It is not true a watched pot never boils (I checked this morning, just to be sure there is no quantum-level effect of the observer). In investment, the same fact holds: one cannot take comfort from frequent discussion among the financial cognoscenti of the possibility of a correction or even a crash.
This seems to fly against the contrarian wisdom usually espoused here. The best money in investment is typically made by avoiding the herd. Near market tops, bears tend to give up, while great buying opportunities are often marked by the perma-bulls finally capitulating. Those who can sell when the crowd only wants to hear good news and buy when the end of finance is being loudly proclaimed will profit handsomely.
Contrarians, then, should surely be reassured by the continued forecasts of disaster by market bears? The bears are still growling about stock overvaluation, deflation, reliance on cheap money from central banks and worse. The more noise they make, the more pessimistic the overall tone and the less likely the market is to be near its peak.
Unfortunately, history suggests this is not right. True, at peaks such as 1929 or 2000, the talk was dominated by people trying to justify the rapid run-up in share prices, just as it is now. But there were still bearish types worrying, often loudly, about excess – as there are now.
The best-known of the dotcom bears was the late Tony Dye, nicknamed Dr Doom after years of warnings of a looming crash. The chief investment officer of the largest UK pension fund manager, he was eventually fired for his obstinate refusal to join in the dotcom boosterism – in February 2000, the month before the bubble popped.
But there was no shortage of concern within Wall Street; while the once-feted bears sometimes became objects of ridicule, their fears continued to be heard in the financial press.
In some ways the same can be said of today. A few bears have switched their views, notably David Rosenberg, chief economist of Canada’s Gluskin Sheff. Others, lionised in 2009 for predicting a crisis, are now dismissed as a stuck record after missing a five-year rally during which US shares have almost tripled.
Investors should not take heart from the occasional appearance of bearish commentary amid the welter of bullishness, then. The same goes for the (quiet) concerns being voiced by central banks. Those who listened hard enough in the late 1990s and during the credit bubble of the 2000s could find central bankers uneasy about the state of the markets – just as a few on both sides of the Atlantic are now worrying about the extraordinarily low volatility in everything from shares to bonds to foreign exchange.
Combine that with high equity valuations, near-record-low bond yields, clear signs of froth in the credit markets and rising corporate leverage, and it is easy to be concerned.
There is one measure that might help calm nerves, though: cash. Merrill Lynch regularly surveys mutual fund managers about the amount of cash they are sitting on, and it is high by historical standards. In the past this has been a good buying signal: holding a lot of cash suggests managers are relatively cautious, leaving scope for them to become more aggressive in their buying, and drive prices even higher.
There is an unfortunate tendency among market strategists to focus too much on mutual funds, merely because solid data are available. Yet mutual fund managers have provided a decent measure of sentiment in the broader market in the past, so their relative caution may be a sign the equity rally has further to go – before the eventual collapse.