Extraordinary Popular Delusions.

Last week was risk on. Stocks shot up 3.7%. If you owned them, you made money. If you owned Treasuries, you did not.

Structurally, not much has changed since we stared into the abyss three weeks ago. Global investors have spent so much time staring into the abyss these last few years that I’ve changed my address labels to “The Abyss.”

Europe is still a chaotic mess of fiscal uncertainty. The U.S. economy appears to be trending down. And all of the geopolitical events that have roiled markets with all the regularity of a Lebron James 30-point performance remain on the table. Iran. Syria. The Arab Spring.

What happened to those summer days when all I needed to worry about was the Reds and my tan?

So, why did markets have such a bumper week?

Possible European bailout? Possible Fed stimulus? What intrigues us are the storylines you won’t read about.

This market spent the first four months of the year heading skyward. Then, sovereign debt and European banking issues cut those gains down to the nub. Last year, same thing occurred. A great start was derailed by bad news (U.S. debt downgrade, European debt issues), only to see the markets recover and shoot upward into this year’s second quarter.

Are we in for an encore performance? Possibly. Though November’s election will add a lot of uncertainty. Or maybe not. Shouldn’t we expect the unexpected?

What could transpire is that the economy derails President Obama’s reelection effort to the point that markets discount a Romney victory. Most private sector participants believe, rightly or wrongly, that a Romney election would be good for the economy. This could have a buoyant effect on markets.

Still, another factor rouses the optimist within.

So many investors are convinced that the stock market is on the cusp of tanking that it cannot help but disappoint them all.

The strategists at the largest Wall Street brokerage firms are as bearish as they’ve been in 16 years. Only 51 percent are recommending stocks. From a contrarian’s point of view, this is great news. The most optimistic these brokerage strategists have ever been was Q1 2001. They loved equities. And equities responded with a two-and-a-half year bear market.

Household investors are also bearish. Very bearish. Having bought more Treasuries in Q1 than the Fed and overseas investors combined. In fact, the Investment Company Institute reports that investors withdrew $7.2 billion from American equity mutual funds the last full week of May. These same investors withdrew $178 billion over the trailing 12 months.

Household investors are, without fail, always wrong when it comes to market calls. So much so that from 1988 to 2007, while the S&P 500 returned 11.81% per year, the average mutual fund investor earned a paltry 4.48% per annum.

Brokerage firm equity strategists and Your Coworker Bob may arrive at their conclusions in different fashion, but they generally end up in the same place. Dead wrong.

Traditionally, when risk aversion has pushed investors en masse to risk-free investments, the S&P 500 has taken the opportunity to shoot upward.

You don’t put money to work when household investors are bullish. If you did, you’d have purchased stocks in March of 2001. And September of 2007. You’d have bought equities right as the market prepared to drop like Bobby Brown’s Q Rating.

All of the contrarian indicators are flashing green.

Yet, one cannot base investment decisions on contrarian maxims and inverse decision mechanisms. Let’s look deeper.

Investors must essentially pose two questions prior to determining whether to stash cash into the market or into the mattress.

First, will public officials, who have gotten policy right more than they’ve gotten it wrong these last few years, watch the euro fall apart or will they unite in an initiative that avoids the worst-case scenario? Will European officials allow their 24-year grand experiment to implode in the face of today’s sovereign debt issues? To throw the European baby out with the Greek bathwater?

Second, will Q2 earnings massively disappoint or, as with every quarter these last three-and-a-half years, will earnings come in positive, leading to a mean reversion in P/E multiples which currently sit at 13.5 to a historical average of about 15?

For all of their austerity tough talk, the Germans realize they have more to gain by saving the EU than letting it fail. And so, after much castigation of their southern brethren, the Northern European industrial overlords will, most likely, steer the EU’s ship into safe harbor. If that occurs, the market will stage a relief rally that raises all ships.

As for the second question, I see the economy slowing.

Last fall, we discussed Lakshman Achuthan of the Economic Cycle Research Institute, and his forecast of a U.S. recession. Looking at the employment and manufacturing data, it looks like that may come to fruition. However, we must also remember that interest rates are low. Inflation remains in check. The Fed wants markets to rise. And U.S. corporations have tightened their belts to the point that stocks may have room to rise anyways. Those are very important tidal currents that could conspire to disappoint all of those bearish investors by pushing the market upwards.

And for all of the media’s contention that this election will be tight, I’m seeing a slow yet deliberate tide turning against the current administration. I’m not saying that a Romney presidency would be any better for the economy. But, the private sector has acclimated to the idea that the current administration cannot turn the ship around. So, any allusion to a Romney victory will likely provide fodder for yet another relief rally.

The S&P 500 is up 5.4% on the year. In April, it was up 13%. I’ll call that a correction. Where does the index head from here? No idea. It seems madness that, given all of the headwinds, markets could elevate from here. Yet, I’m optimistic.

In Charles Mackay’s seminal effort, Extraordinary Popular Delusions and the Madness of Crowds, he wrote the following: “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Mackay’s book was written in 1841. Yet, even today, no words have ever been truer. So, when looking at current circumstances and likely outcomes, we will gauge the direction and sentiment of the crowd. And walk away.