The Tepper Effect

Four weeks ago sentiment was extremely negative. The market had been down for the better part of the past four months and that served to make the crowd very bearish. Hedge funds were no exception, as "de-risk" and "risk off" became the new catch phrases. Hedge fund surveys were showing very low equity allocations and second quarter investor letters written during the Summer were dour with few exceptions.

Four weeks and 11% later sentiment has improved and equity allocations are likely higher. However, four weeks is not enough time for allocations to move to a bullish extreme. Especially, considering that we are coming off of four months of de-risking and extreme negative sentiment. My best unscientific guess is that allocations are now neutral.

While generally sentiment swings from extreme to extreme, I doubted whether sentiment would move back to extreme bullishness as economic growth is still slowing and earnings should follow. Generally, when the market goes higher the primal urge to join the herd grows stronger and any excuse to join the herd will do. But the news flow has been so negative recently that it has not been conducive to extreme bullishness.

Then David Tepper steps on CNBC and gives the overgrown primates the intellectual cover they need to join the herd. A brilliant sounding argument that allows them to turn bullish regardless of the news flow. Heads I win, tails I win. Can't lose. If this argument catches on it has the potential to swing the crowd to extreme optimism and move hedge funds to bullish equity allocations. That would set up a very dangerous environment but it would mean higher prices in the interim.

For the purposes of this post, put aside what you think of the argument, as the perception of the crowd is reality (I think Tepper's argument is hogwash and will explain why in a later post). If this argument catches on it has the potential to fuel a continued rally.

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