Bullish sentiment rules … cash levels are down as fund managers flood stocks … crazy “red flag” valuations … how to trade this market with greater safety This will go down as a year with among the most bullish sentiment since the 1987 inception of the American Association of Individual Investors survey. So says Jason Goepfert, founder of SentimenTrader, which provides market sentiment-focused research to its clients. On one hand, this is great news. This bullish sentiment is the fuel that has propelled the S&P to what’s likely to be its second consecutive year of 20%+ returns and is likely to get us off to a solid start in 2025. On the other hand, Goepfert notes that extreme bullishness is rare and could foreshadow poor returns in 2025. From Goepfert: There is little dispute that stocks are currently at some of the highest valuations in history by nearly any metric. [History shows] a surprisingly large amount of money is not only willing to ignore, but also chase, [market momentum] … As a sign of just how optimistic folks have been this year, one of the most popular surveys of individual investor sentiment has spent only two brief weeks with (barely) more bears than bulls. Not great. But let’s challenge it. If this were true, we’d see evidence such as low cash balances and heavy buying despite lofty valuations that scream “overvalued.” Is this happening? Tuesday brought word that fund managers are now holding the least amount of cash going back to at least 2001 A survey of global fund managers just clocked in with its lowest cash allocation on record. Here’s CNBC: The average cash allocation level of participants in Bank of America’s Global Fund Manager Survey fell to 14% underweight, according to data released by the bank on Tuesday. That is the largest underweight position for currency compared with stocks since at least 2001, when the survey began, the firm said. Put simply, the data “shows super-bullish sentiment,” investment strategist Michael Hartnett wrote to clients on Tuesday. He cited interest rate cuts from a “compliant” Federal Reserve and expectations for growth under President-elect Donald Trump as drivers of the rush into stocks. For some context, this “14% underweight” reading marked a huge reversal from November’s “4% overweight” reading. The 18-point drop was the biggest monthly decline in roughly half a decade. Meanwhile, investors continue buying stocks at crazy valuations The examples of this are everywhere. Here are a few such stocks along with their price-to-earnings (PE) ratio: - CyberArk (CYBR): 1,139
- Gilead Sciences (GILD): 1,008
- CrowdStrike: 689
- Palantir: 376
- Datadog: 278
- Cava: 253
- Broadcom: 192
Let’s zero in on Palantir (PLTR), which is a data mining and analytics group. Now, Palantir is a great business. I’m not questioning that. The issue is whether it’s a wise investment at today’s price. We just looked at its PE ratio, but let’s evaluate it a different way. Before we do, however, let’s start with some context by recalling the Dot Com bubble. Older investors will remember Sun Microsystems. It was a tech stock darling that was creating overnight riches for investors in the late 1990s. From 1996 through its high in 2000, the stock rose from about $5 to $64 for gains of well-over 1,000%. Of course, when the bubble burst, so too did Sun Microsystem’s stock. By 2006, Sun had round-tripped, falling back to $5, meaning it had lost all its gains. Here’s how that looked… 
In 2002, Scott McNealy, the CEO of Sun Microsystems, looked back at the jaw-dropping rollercoaster ride and had the following to say to investors who bought near the top and found themselves destroyed when the bubble burst: Two years ago, we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking? Well, investors weren’t thinking. They were wrapped up in the excitement of the transformative power of the internet… they were watching explosive gains in internet stocks… and they wanted to get rich. Now, with this context, how expensive is Palantir today? We’ll maintain McNealy’s yardstick of revenues. Is it 10X as it was with Sun? Maybe 15, or 20? Nope, it’s 65X sales. I’m reminded of a quote from publisher/writer William Feather from the mid-20th century: One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute. So, does this mean it’s time to bail on the market? No, that’s not our kneejerk response. A stock’s price and valuation matters…eventually. But bullish momentum fueled by enthused investors can push “eventually” out a long, long time. We’d be wise to remember two quotes on this topic. From John Maynard Keynes: Markets can remain irrational longer than you can remain solvent. And Peter Lynch: Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves. That said, it's critical that we have a plan in place to protect our wealth from the stock market collapse that will eventually arrive. To resolve the tension between the risk of a melt-down and the possibility of a melt-up in 2025, there are a handful of steps we’ve encouraged investors to take First, categorize your portfolio holdings into two groups: low-conviction and high-conviction. A high-conviction stock is a holding that you believe is a multi-year (or multi-decade) portfolio cornerstone. You believe its long-term merit makes its valuation irrelevant. You recognize that such a stock will lose value in a bear market, but you’re fine with that. You can imagine this holding imploding, say, 55%, and you would still hold without batting an eye. A low-conviction stock is anything that doesn’t fit this description. After sorting your stocks along this binary, forget your high-conviction stocks. Delete them from whatever app you use to monitor the market. After all, their price movements are irrelevant. You don’t want to be tempted to sell them if you see a major decline and your emotions tempt you to act rashly. But for your low-conviction stocks, a different approach is mandatory. Consider adopting a trading mindset that: 1) has you trading only the market’s strongest stocks, and 2) incorporates a stop-loss system that helps you define and mitigate your risk. As to the market’s strongest stocks, we profiled a way to do this last week when we highlighted Luke Lango’s new trading system, Auspex. It’s an advanced market screener that searches out stocks with superior fundamental, technical, and sentiment criteria. It scans more than 10,000 stocks looking for the select few that are anchored in operational strength, have technical support and tailwinds, and are being buoyed by investor sentiment. As you’d expect, this creates a high bar that only a select few stocks pass each month. The intended hold period is only one month (unless Auspex flags the same stock again the following month). This way, you keep your wealth aligned in the “best of the best” of fundamental, technical, and sentiment strength on a month-by-month basis. You can learn more about Auspex from Luke right here. As to incorporating a stop-loss system, I’d point you toward our corporate partner, TradeSmith. They’re one of the leading quant shops in the entire investment industry. Unlike how most investors use trailing stops (a blanket “20%” lower), TradeSmith’s trailing stop system factors in the specific volatility of any given stock/ETF to help investors answer a crucial question… When you’re in a pullback, how do you know whether it’s just normal volatility to ride through, versus a “this time is different” drawdown to avoid immediately? You can learn more about it here. Finally, take advantage of market/economic trends that are most likely to support robust earnings in 2025 Taking the spotlight here is, unquestionably, artificial intelligence (AI). But it’s the next phase of AI stocks, specifically. Here’s our macro expert, Eric Fry: The AI Revolution is about to enter a new phase, and a different set of companies will lead the way. The AI Seven is about to become the AI Eight… Nine… and beyond… We’ve had the AI enablers. Now enter the “AI appliers.” Unlike the AI enablers, these companies are not at the forefront of producing the material needed to create AI. Instead, they are employing AI technology within their own products and services. AI appliers are everywhere… and growing by the day. That universe includes companies as diverse as beauty-products purveyor Coty Inc.(COTY), gold and copper explorer Ivanhoe Electric Inc. (IE), and industrial-solutions provider Rockwell Automation Inc. (ROK). Clearly, many of these companies operate in niches that are not normally associated with technology. So, they are still lying low. To help investors find the top AI appliers for 2025, Eric has been collaborating with Louis Navellier and Luke Lango. Earlier this week, they published their research in a video broadcast you can check out here. Coming full circle… As I write Thursday morning, the market is trying to bounce back from yesterday’s post-FOMC-meeting rout. But whether today’s rebound gains steam or fizzles, odds are strong that animal spirits will return to this market soon. We don’t want to miss this. As Luke told me in our recent interview, “just like in a movie where the last 30 minutes are always the best, the last part of a bull market is also always the best.” But the longer we remain in today’s market, the greater the importance of having our risk mitigation plan. If you haven’t taken the time to think through what yours is, please make that a priority today. Have a good evening, Jeff Remsburg | 
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