Posted by Joseph Y. Calhoun, III

Usually when I measure market sentiment, I look at what individual investors are saying about the market. When the majority of individual investors are bearish, I tend to be bullish and vice versa. Institutional investors are a different animal although they do tend to move in herds just like the individual. These investors biggest concern is relative performance. They need to outperform their benchmark (for instance the S&P 500 for a large cap manager) to keep their jobs, so if they are lagging they get desperate to catch up. I said a couple of weeks ago that if the market was able to move above resistance at 950, a lot of bears would have to throw in the towel. Here’s an interesting comment from Jeremy Grantham’s quarterly letter to investors:

And the rally did indeed leave institutional investors feeling left behind. In an informal survey at a recent meeting of 150 or so institutions, those admitting to feeling nervous about underexposure to risk outnumbered those feeling too aggressive by a neat 10 to 1! This also suggests how a speculative rally can keep going longer than reasonable investors expect.

In other words, institutional investors are likely to be buying dips and playing catch up. While that is good news for those of us already long, it also should give us pause. These big investors aren’t buying because they believe the economy is recovering or some other fundamental reason. They are buying because they think they have to. That worries me, but for now, I suspect more buying is on the way.

Grantham’s quarterly letter is, as usual, required reading. He is a smart guy and conservative in his approach, although I must admit he’s a little too Malthusian for my taste. Read the letter and you’ll see what I mean.