Contrary Opinions

By Greg Donaldson and Mike Hull

As we write the Dow Jones Industrial Average and the S&P 500 are hitting new all-time highs. These new highs are coming a little faster than we thought they would, but then our guess on timing is no better than the next guy's -- it's just a guess. However in our June 4th blog we said that, on balance, the primary forces driving the market were likely to push prices higher in the coming year.

We cited the drivers of higher stocks prices would be:

1. Solid earnings and dividend growth
2. The market was undervalued according to our Dividend Valuation Model.
3. Sub-par economic growth
4. Investor Sentiment was too bearish

Points 1 and 2 would seem to foretell better stock prices, but points 3 and 4 might seem a bit upside down. Sub-par economic growth would not seem to be a precursor of higher stock prices, but if you think about it for a moment, it makes sense. Sub-par economic growth would mean that the Fed could cut interest rates. Last week, retail sales data showed a sharp slowing. Stocks rallied on the news.

But we suspect one of the main reasons stocks have pushed higher in the face of lots of worries about oil, terrorism, and the sub-prime mortgage mess, was the very bearish tone of investment advisors in late May. In our June 4th blog, we showed the following chart of Tickersense.com's sentiment poll.

Among investment bloggers, many of whom are professional investment advisors, nearly 47% were bearish at the end of May.

We have found, over the years, that such a high rate of bearishness has usually been a positive sign for the market.
High rates of bearishness are often associated with high rates of short sales. A short sale is accomplished by borrowing stock from a broker and then selling it. The hoped for result is that the stock will fall and then can be repurchased at the lower price, thus producing a profit.

But if the short seller is wrong and stocks go higher, to avoid big losses, he or she must buy back the stock to cover or close out the short. The problem is as these short sellers cover their shorts they are doing so in the face of rising stock prices and their purchases provide additional momentum to rising prices.

This will be a big week for the markets. Fed Chairman Bernanke will be giving his semi-annual economic and inflation report to Congress, many companies will be releasing second quarter earnings, and we will getting a fresh look at the Consumer Price Index.

Finally, we are also getting into the season where many important companies will be reporting dividend hikes. We will be detailing some of the surprises here.

The bottom line on all of the balls we have thrown up in the air here, is that we still believe the primary drivers of stock prices are pointing north.