Monthly Commentaries

Sentiment – July, 2008

July was another poor month for equities with the S&P dropping just under 1% and the TSX down 6%. With July's headlines dominated by continued price declines in the U.S. housing market and financial turbulence at U.S. government supported mortgage purchaser Fannie Mae, investor sentiment dropped to levels not seen in a quarter century. Investors across the globe are now completely convinced that equity markets will continue lower indefinitely. Consider the following data concerning investor sentiment: • Individual investors are only 20% bullish - lowest reading in over 20 years • Newsletter writers are only 28% bullish - lowest reading since 1995 • 81% of fund managers believe earnings estimates are too high

It is rare to see such bleak assessments of the future from all facets of the investment community. This extreme pessimism in sentiment measures is more consistent with bottoms than with an imminent collapse in the equity market. This is because the pessimism reflects panic sales that these investors have already made. It doesn't reflect the sales or purchases these same investors will make in the future. Investors, particularly in declining markets, believe the equity market reflects current news and data. As one poor piece of news follows another, prices decline, and speculators drive prices inexorably lower. What gets lost in this movement is that markets don't reflect the present but discount the future. When equity markets inevitably start to rally, bearish commentators focus on current news for reasons why the rally can't continue. It is because equity markets reflect future news that they often start rising during periods where the bad news continues.

Timing markets is always a losing exercise. The typical individual investor is overly optimistic and aggressively invested at market tops, and underinvested and too defensive at market bottoms. The focus should be on investing in a disciplined manner in strong companies that will allow an investor to participate in the inevitable recovery. The extreme negative sentiment indicates that a turn in markets may happen sooner than many expect. Arthur Heinmaa, CFA Managing Partner