There's an adage on Wall Street: When the last bear says buy, it's time to sell. If that's the case, stock market bulls may want to think about hibernating.
Robert Shiller, the Nobel Prize-winning economist who coined the term "irrational exuberance" and warned about both the stock market bubble of 2000 and the housing bubble of 2008, said late last month that he thought stocks could go up perhaps as much as 50 per cent from here. He also said technology stocks, which are up 20 per cent this year, looked cheap. Mr. Shiller had said as recently as January that he thought stocks were again in a bubble. Now not so much, apparently. And he's not the only bear shedding his fur.
In early May, Jeremy Grantham wrote his own mea cupla on questioning the bull market. He said he long expected higher-than-normal profit margins would fall, taking the stock market with it. But Mr. Grantham said he now thought changes in the global economy could keep profits elevated. He wrote in a letter to clients that while-this-time-is-different logic was dangerous, assuming "that things are never different" could be ruinous as well. Grantham concluded that the chance of a serious market decline in the near future was pretty minor.
The basic logic of the Wall Street adage is pretty simple. There is a fixed number of investors and they are either all in the market or all out. Market climbs start when some investors decide it's time to get back in, but skeptics remain. Bull markets -- as another Wall Street saying goes -- climb a wall of worry. But eventually the skeptics are drawn in as well, convinced that whatever kept them on the sidelines was bad analysis. When the last bear throws in the towel, there are no buyers left, and stocks inevitably fall.
That's not how the real world works, of course. Emerging markets are hatching new middle classes and investors all the time. Tens of millions of Americans have 401(k) plans that are constantly putting money into the market on autopilot. Stocks often move based on earnings surprises or CEO resignations, not always investment flows. But the logic should hold in general. As the number of new buyers shrinks, the lift to the market slows.
Mr. Shiller and Mr. Grantham were prominent, persistent and vocal bears. And it's particularly worrying, at least when it comes to the adage, because they are flipping when the market is again at a record high and surging. The S&P 500 closed within striking distance of 2,500 on Friday and is already up 9 per cent this year.
The trick is knowing whether they are the last ones. Put another way, trying to figure out if there is cash "on the sidelines" waiting to be invested is not easy. One way analysts and market prognosticators track this is by looking at fund flows. But complicating matters lately are exchange-traded funds, which in the move to passive investing have sucked up many of the dollars that used to go into mutual funds. So while investors have pretty consistently pulled money from U.S. stock mutual funds, much of it may be going into ETFs and not to the sidelines.
Still, the net effect for stocks is negative. Add the flows together, and investors have pulled a combined $149-billion out of equities since the beginning of 2008 through April. Is that money on the sidelines? Maybe not. In the same period, investors poured about $1.2 trillion into bond funds. And some of that money may not come back to stocks. Older baby boomers will probably continue to shift more of their portfolio into bonds. Still, bond returns have been relatively good because interest rates have remained low. A sustained upturn in rates could push that cash, even reluctantly, into the market.
On top of the bond investments, individuals do seem to have a lot more idle cash than they used to -- $11.3-billion, up from $8-billion at the end of 2009.
Some have tried to argue this isn't cash on the sidelines, either. While the absolute number is up, so is the whole pie. Individual households have about 15 per cent of their total assets in cash, which is down slightly from 16.5 per cent in 2009. Perhaps there's less cash on the sidelines. But it's not obvious that's a clear signal, either. People tend to have rainy day funds, but those funds track income, not overall wealth. Just because your stock or bond portfolio has gone up doesn't mean you need a larger rain day fund. In fact, for a lot of people the opposite might be true, and if the market continues to rise, more and more of that cash might jump in. All that means is that Mr. Shiller and Mr. Grantham most likely aren't the last bears. The ranks are thinning in a hurry, but a few are left to keep charging.
Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.