Is The Stock Market Frothy?

Year-to-date the SPDR S&P 500 Fund (NYSE:SPY), the SPX ETF, is up 8.6%. That’s a good year but not a blow-out, not yet. The SPY has been known to have 10, 20 and 30% swings in a year. So again, 8.6% is good, but far from frothy.

Think about it. The world is telling you the market is frothy yet the main index is only up 8%. What that does tell us is there are still plenty of skeptics that need to jump in at some point.

Sentiment is a great way to know if everybody is in. There are two ways to use sentiment. One is to simply look to see if it’s high or low. For us, that never tells the real story.

The way we like to use sentiment is to compare it versus market action.

For example, if the market goes up, it’s normal that bullishness rises. To us, sentiment up in an up tape doesn’t tell us too much. It’s normal.

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Same thing on the downside. If the market goes down and bearishness builds, that’s normal. It also doesn’t tell you so much.

Many traders try to pick tops and bottoms by saying sentiment is too high or low. We think that stat is misleading. How we like to use sentiment is versus market action.

If the market rips higher and people get more bearish, what would you say? We’d say nobody believed the move and they’ll have to give up and jump in with everybody else. That will then push the market even higher.

That’s what we mean by comparing sentiment changes versus action and the market’s directional changes. That’s the case today.

We like to use The American Association Of Individual Investors, AAII, survey.

As of their last read on May 24th, they said Bulls and Neutrals are about at the historical average. Bears are down and are “slightly below” the historical average, now three out of the last four weeks. That’s not such blow away news, is it?

Let’s put it in context though. We ask you, even if the market were to-the-moon, does that sound frothy? We don’t think so.

AAII is showing average bulls, bears and neutrals as a face-ripping market hits new highs regularly. Ho hum, average. Nobody feels forced to jump in. Not yet.

But they will.

What you learn from these stats is that everybody is not in. People are still on the sidelines. A lot of people. The market is therefore not frothy.

Kudos to CNBC for a great interview with Professor Jeremy Siegel of Wharton this past Friday.

He clears up the speculation regarding if everybody is in. Dr. Siegel provides painstaking detail as to why rates are still low. While Dr. Siegel has been known to be a perma-bull, he’s also been correct.

He told CNBC that people have not bought into the market yet. People are still shaking from the crash of 2008-09.

Let’s see what he said. We think it’s key when coming to a conclusion regarding if the market is frothy.

“I’ve always been opposed of the idea that it’s a sugar high all created by the central banks. I think the low interest rates are due to very fundamental factors in this economy; low productivity growth, low GDP growth, a lot of risk aversion still out there from the crash of ‘09, an older investor class that is naturally more risk averse, regulatory demands for liquidity. All those things are the primary reason [for low rates]... This low interest rate environment is going to be in place for many years to come, it’s not just a central bank phenomenon.”

Years to come. So we ask you again, is the market frothy?

Dr. Siegel answered the question we posed last Thursday. Why didn’t bonds tank after the Fed said they were going to initiate the final taper later this year? Because bonds aren’t down due to central banks. Bonds are down because investors are still risk averse.

Here’s the chart of the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) after the taper news last Wednesday.