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Markets: Why the 'sell everything' crowd has been really wrong

If you believe it's time to sell, you're in a pretty lofty club — Jeff Gundlach, Bill Gross and Carl Icahn are all members, just to name three.

Many investors, in fact, have taken up the bearish cause, yanking money from U.S.-focused stocks and shifting it overseas. By one measure, emerging market equity funds are seeing their largest inflows ever of investor cash. Bonds are raking in money, reflecting the pervasive risk-aversion dominating retail investor sentiment.

All of this, of course, is the perfect setup — for a market rally.

Despite a decidedly mild downturn from late July to early August, the stock market has met all the pessimism with a convincing upturn. Not only was the S&P 500 up 6.7 percent year- to date heading into Monday trading, but it has staged a 19 percent rally off the February closing low, a time when it seemed as if U.S. markets were descending into what would be a prolonged funk.

Yet some of the market's biggest names are in the "sell everything" camp, as Gundlach, the widely followed and often-prescient CEO of DoubleLine Capital, described his philosophy in a recent interview.

"The artist Christopher Wool has a word painting, 'Sell the house, sell the car, sell the kids.' That's exactly how I feel — sell everything. Nothing here looks good," Gundlach told Reuters. "The stock markets should be down massively but investors seem to have been hypnotized that nothing can go wrong."

The stock market has broadly been pretty flat since Gundlach issued his dire warning, which came amid a bevy of similar forecasts.

A trader stands outside the New York Stock Exchange.
Mario Tama | Getty Images
A trader stands outside the New York Stock Exchange.

Nick Colas, chief market strategist at Convergex, has been keeping a tally of the big-name bearish forecasts in addition to Gundlach's, and it looks something like this (as related in one of Colas' recent morning notes):

Stan Druckenmiller (May 4 at the Ira Sohn Conference): "Get out of the stock market."
George Soros (June 9, as reported in The Wall Street Journal): "The billionaire hedge fund founder and philanthropist recently directed a series of big, bearish investments, according to people close to the matter."
Carl Icahn (June 9, on CNBC): "I don't think you can have (near) zero interest rates for much longer without having these bubbles explode on you," while also saying it's difficult to assess when exactly that might occur.
Bill Gross (in his monthly investment letter): "I don't like bonds. I don't like most stocks. I don't like private equity."

The four prominent investors were not immediately available to respond to CNBC's requests for comment.

"When a cluster of high-profile hedge fund and long-biased managers go out of their way to give dire warnings about the U.S. equity market with stocks sitting at or near all-time highs, any sensible investor needs to pay attention," Colas wrote. "These are people with access to information that most market participants could only dream of having."

The market calls are decidedly contrarian at a time when the market is enjoying a prolonged powerful stretch.

So what do they know that the rest of the market does not? Colas, in an emailed response, took a stab at it:

1)They are worried over escalating geopolitical events like terrorism or other destabilizing catalysts. Every senior hedgie I have ever met has a solid pipeline into senior global policymakers past and present. And the only thing that would spook everyone from Soros to Gundlach is geopolitics.
2)They all think the world has drifted too far from what they believe is a sustainable economic or social model. Soros must feel that his globalist worldview is deeply under threat from Brexit and now (Donald) Trump. Of course he would be bearish if he saw the world moving in a direction he thought was retrograde and unhealthy. As for the bond guys, they have had it drummed into their heads since Volcker that Fed credibility is the be-all, end-all of analyzing monetary policy. Now that the Fed seems behind the curve, they are freaking out.

Whether their concern will be enough to turn the market around is a point of contention on Wall Street.

History both distant and recent suggests that, given similar conditions, the market is more likely to rally than retreat.

Jeffrey Saut, chief investment strategist at Raymond James, has what may sound like a less-than-comforting reason why he has remained a bull in the face of his peers' bearishness: "The stock market has decoupled from the fundamentals."

That means conditions that otherwise might act as headwinds have been neutralized. They include the continued weak state of earnings (a 3.5 percent second-quarter decline, continuing a streak of five negative quarters), a wobbly macroeconomic picture (average GDP growth of 1 percent in the first half) and a disconcerting political landscape, with a high degree of uncertainty in a vicious battle between Hillary Clinton and Trump.

To Saut's point, consider this: Bank of America Merrill Lynch's proprietary and highly accurate Sell Side Indicator is a technical measure of the stocks-to-bonds ratio in portfolios. When one side gets out of whack, that's a good sign that the market's going to move in the other direction.

The indicator for months has been flashing a major buy sign, but Savita Subramanian, the firm's equity and quant strategist, warned in May that fundamentals indicated the market instead could be headed for a 15 percent drop. (Subramanian said the market was too complacent about the possibility of a summer rate hike. The market, it turns out, was right that the Fed's not going anywhere.)

To buy or sell?

Saut and a number of other Wall Street strategists see longer-term indicators, particularly the length of time it took between new all-time highs, as historically accurate predictors that the most likely direction is up.

As things have progressed so far, at least, fundamentals are losing and technicals and central banks are winning.

And then there's the Fed.

In the near term, at least, there's virtually no chance the U.S. central bank is going to stand in the market's way by raising interest rates. Fed funds futures contracts indicate just a 46.5 percent chance the Fed will hike before the end of the year.

Still, investors are pulling cash from the market.

Equity mutual funds, which more closely reflect retail investor behavior than shorter-term exchange-traded funds, have seen $173.4 million of outflows this year, according to Bank of America Merrill Lynch. The money is flying into ETFs that play the emerging market trade.

Equity funds focused on the group took in a record $6.7 billion in July, then another $600 million in the first week of August, while EM bond funds recorded a record $1.8 billion inflow in July and another $300 million so far this month, according to TrimTabs.

Buyers have been rewarded, with the Vanguard FTSE Emerging Markets ETF up nearly 30 percent since the February lows.

So while "sell everything" may be the theme among some of Wall Street's most influential minds, it may not make for the best investment strategy.