You probably want to sell stocks, now

On January 11, I shared an observation “You probably want to invest in stocks

The great thing about sharing written observations is the ability to go back and read what was going on in the past to learn from it.

On January 11, I wrote:

You probably want to invest in stocks right now, I bet.

If you are already invested in stocks, you probably want to be more aggressive in investing in stocks. Maybe it’s selling bonds to buy more stocks, or investing that extra cash, or something really aggressive like adding leverage or buying more risky stocks.

I believe this because investor sentiment is dialed up and 2020 started out about as enthusiastic as it gets. Well, and we’re getting calls from people wanting to invest.

Then, included the Fear & Greed Index dialed all the way up to 97, Extreme Greed.

fear greed index

I went on to write; (I’m bolding the key points this time)

The Fear & Greed Index is driven by seven different investor sentiment indicators. If you’re an investor, I encourage you to use it as a gauge for your own enthusiasm and panic.  When you feel one way or another about the future direction of the stock market, check the indicator to see what emotion is driving the stock market now.

Avoiding costly mistakes is essential in money management, so if we can help you avoid buying too high and then tapping out at the lows, that’s an edge. That’s the behavioral counseling we do; investor behavior modification. It’s one of the main observations I share here. If nothing else, I hope I can help you avoid making costly emotional decisions as many investors do.

I included this chart of the stock index at all time highs.

stocks stock market at all time high

I then wrote: (I added the bold this time)

Investors sentiment trend to follow price trends, so investors or trend followers.

After prices trend up, investors get more bullish, expecting the gains to continue.

After prices trend down, investors get more bearish, expecting the losses to continue.

So, it isn’t a surprise to see this level of enthusiasm, considering the stock index is at an all-time high.

What has changed?

A lot has changed since then.

First, the S&P 500 stock index which most investors use as a proxy for “the stock market” is down -34% from it’s high reached on February 19th. To put the fall into context, I included the history going all the way back to the 50s. This is now the 4th deepest decline since then.

The speed of the decline was most impressive.

The next chart is the price trend of the S&P and Dow Jones year-to-date. The decline happened very fast, in just a few weeks.

By March 12, the Fear & Greed Index was pegged back to 1 indicating “Extreme Fear.”

 “Be fearful when others are greedy and greedy when others are fearful.”

 ― Warren Buffett

I know. It’s much harder than it sounds!

But at the extremes, which is what I mostly point out here on ASYMMETRY® Observations, is when we want to step away from the crowd and shift from trend following to countertrend tactics.

That’s what I’ve been doing.

I know you think “it’s different this time” because of the Coronavirus COVID – 19 and such. Now, the Federal Reserve has committed to taking unprecedented actions even more than after 2008. The US government is printing even more money than before.

It all seems so uncertain, but it always is.

“Don’t fight the Fed.”

“Don’t fight the Fed” suggests investors can do well by getting in synch with monetary policies of the Federal Reserve Board, rather than against them. The Fed has lowered rates to zero and announced it will be buying traditional securities including bonds and ETFs as “The Fed Goes All In With Unlimited Bond-Buying Plan.” I’ll share my detailed observations of it later.

Yesterday, I had a significant cash position, so was looking for the most likely asymmetric risk/reward positions to take. Tactical trading isn’t easy. It requires tremendous discipline, stoicism, patience, skill, ability to be wrong, and acceptance of the uncertainty.

RISK MANAGER / RISK TAKER

I’m a tactical risk manager and also a risk-taker. I increase and decrease exposure to the possibility of profit or loss based on my estimates of asymmetric risk-reward. After prices have already fallen over -30%, we have to realize the risk level decreases. It doesn’t seem that way, because of the volatility expansion. Prices swing wider up and down at the lowest lows, so there is nothing easy about taking a risk when its the lowest.

If you are like the majority of investors, you are feeling “Extreme Fear” right now as you fear taking on more loss. Below is the Fear & Greed index over time. Notice it oscillates between fear and greed. After prices trend up, it enters the red zone I colored. After prices fall, it enters the green zone.

Clearly, this has been one of the most staggering waterfall declines in American history. As such, investor sentiment has followed the price trends down.

So, you probably want to sell your stocks right now.

I’ve been hearing from other financial advisors who aren’t tactical like me and don’t increase and decrease exposure to asymmetric risk/reward as I do, saying their clients were tapping out on these big down days the past week.

That’s what I hope to avoid with our clients.

If you tap out, I would NEVER know when you could get back in.

Would you feel better of prices fall another -30%?

Or, would you buy back if prices trend back up to all time new highs?

What would it take?

I have no idea.

I want to avoid that situation because I have no idea how to resolve it. So, I prefer to try to apply my drawdown controls to manage the downside the best we can to keep it within our clients tolerance and capacity for risk.

This is why I actively manage risk by increasing exposure to risk and reward over time. It ain’t perfect, but it doesn’t have to be, as evidenced by my 16-year track record. I just need the average gains to be larger than the average loss over time.

It’s what I call ASYMMETRY®.

That’s all for now. I’ve got some good stuff in the queue, so if you haven’t already, I encourage you to sign up for automatic email alerts of new observations.

I also encourage you to go back and read You probably want to invest in stocks from January 11th and think about what has changed since then. This has been one of the most fascinating swings in US history, so let’s learn all we can from it!

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Panic selling drove a waterfall decline and washout for the stock market

Growing up in East Tennessee and the Great Smoky Mountains, I observed a lot of waterfalls.

Wiki says a fall of water is an area where water flows over a vertical drop or a series of steep declines in the course of a stream or river.

According to National Geographic, a waterfall is a river or other body of water’s steep fall over a rocky ledge into a plunge pool below. Waterfalls are also called cascades. The process of erosion, the wearing away of earth, plays an essential part in the formation of waterfalls.

waterfall decline in stocks stock market

What we have witnessed in the global equity markets is a waterfall decline, the question now is if the plunge pool has developed.

water fallAn overhang in a waterfall can sometimes protrude out enough to form a base, or even drive the water to flow upward for a while, but the waterfall isn’t over until the plunge pool develops.

waterfall overhang spring hill

Using the S&P 500 stock index as a proxy, it’s pretty clear there wasn’t much of an overhang along the way. For example, in the middle of this 3-year chart, we see how the decline in late 2018 played out. It had a lot of overhangs as the stock market was swinging up and down for several weeks.  Now, compare that to this time…

SPY SPX

What we have here is panic selling.

Investors tend to underreact and overreact to new information.

Underreaction: Trends begin to drift in a direction as people initially underreact to change, so the price trend unfolds gradually.

Overreaction: Sometimes, investors overreact to new information, so the price is driven too far, too fast. When the market overreacts, prices overshoot too high, or too low.

At the bottom of a waterfall is a plunge pool, where the water settles. What does the plunge pool look like as it develops? It’s a floor that has enough support the water stays were it is.

The trouble is, in the market, we don’t physically see the rock bottom. Unlike in physical science, an exchange market is a social science because it’s human behavior. Don’t think this is humans? Maybe it’s the computer algorithms? They are created and operated by humans.

I apply quantitative tools to get a read on how extreme investor sentiment is.

In analyzing market trends and price action, we can see what is going on with market internals, such as breadth. The NYSE Bullish Percent was developed by Abe Cohen was the first breadth indicator. Abe Cohen was an early pioneer of Point & Figure charting and created the NYSE BP in the mid-1950s. The NYSE Bullish Percent is a market risk barometer that measures the percent of stocks listed on the New York Stock Exchange that have a Point & Figure buy signal, so they making higher highs, so they are in uptrends. The NYSE Bullish Percent is washed out. It hasn’t been this low since the waterfall decline in October 2008.

NYSE BULLISH PERCENT

The challenge with countertrends is they can also trend farther than you would ever believe is possible. It’s because markets don’t follow a normal distribution. Instead, market trends have fat tails, meaning some gains and losses exceed an otherwise normal distribution, as we see in physical science. As such, the overreactions can overshoot and just keep overshooting. We never know for sure when a trend has stopped. What we can do, however, is apply quantitative tools to gauge and guide. I use these as a guide and barometer for overall market risk.

The percent of the S&P 500 stocks above the 50-day moving average is washed out to 1%. In fact, only 7 of the 505 stocks in the S&P 500 are in a short term uptrend. While in a big bear market such as 2008-09, these conditions can continue for a long time, historically, this lower level of risk eventually offers the potential for asymmetric risk/reward. That is, the possibility for reward is greater than the risk it takes the achieve it. Or, the magnitude for a reward is greater than the downside risk, which can be predetermined with options or an exit (i.e., stop-loss.)

$SPXA50R breadth is washed out crash 2020

A material change that has occurred the past week is the percent of S&P 500 stocks above their 200 day moving average, or longer-term uptrends have washed out. Only 5% of the stocks are in uptrends now, so 95% of them are in long term downtrends. That doesn’t sound good, but when it reaches an extreme, it suggests to me the selling pressure is intense and could eventually dry up.

percent of stocks above 200 day

This is about as oversold the stock market gets, both internally looking at the individual stocks and the indexes. Sure, it can get more oversold and stay there for as long as sellers have the desire to sell, but it has reached the point the odds of a short term reversal is increasing the lower it goes.

Yesterday I asked: where do you think we are in the cycle of market emotions?

THE CYCLE OF MARKET EMOTIONS

Clearly, when stock indexes drop 8-10% in a single day after already well off their highs, it is driven by emotional panic.

The US Investor Sentiment poll from AAII is released on a few day’s time lag, but Bearish % of those polled is another measure up to 2008-09 levels.

AAII INVESTOR SENTIMENT MARKET CRASH 2020

 

To no surprise, the Fear & Greed Index was penned all the way back to 1 after yesterday’s close.

fear greed panic market crash 2020

What we have here is a washout. A washout is an event or period that is spoiled by constant or heavy rain. We may see more rain, but it’s a washout nonetheless. A washout in the stock market is when prices have been flooding down so hard, so broad, it seems like a washout of rain.

As you can imagine, with a waterfall, heavy rains increase the volume and speed of water flow. A washout pushes the river to its limits.

The desire to sell has been overwhelming any buying interest that remains for a few weeks now. This has been the fastest decline in US stock market history. I guess we shouldn’t be so surprised if we believe a trend stretched far in one direction is more prone to snap back harder and faster. That’s what we’ve seen here.

This is the end of the longest bear market in US history, and it has indeed ended with a bang. That also means this is the beginning of a bear market. What we don’t know in advance is how long it will last or how low it will go. If we knew it would be -50%, we could simply sell short and profit from the fall. If we knew this was “the bottom,” we could use leverage to maximize gains on the upside. But, none of us know the outcome in advance, not the biggest banks, not the largest asset managers, and neither you nor I. The edge I do have is accepting this reality and embracing it to the point I drove me to create risk management systems to limit the downside when I’m wrong and focus on the things I can control. I’ve operated tactically through periods like this many times before in the last two decades, so I’ll just do what I do, which means I’ll execute many entries and exits until we find the trend. In conditions like we’ve seen this year, they’ll be countertrends. Once trends do develop, they’ll be trend following.

What I’ve typically seen in past bear markets is many cycles up and down along the way. That isn’t what we’ve seen this time, so far. This reminds me more of September 11, 2001, after the World Trade Center was attacked. The difference is, the S&P 500 was already down about -17%, and since the planes hit the World Trade Center in New York, the NYSE was closed. The New York Stock Exchange remained closed until the following Monday. This was the third time in history that the NYSE experienced prolonged closure, the first time being in the early months of World War I[2][3] and the second being March 1933 during the Great Depression.

It may not play out this way this time, but countertrends should be expected. Here is what the stock market did after the exchange opened after September 11. The SPX dropped -12% quickly, but then investors become patriotic, and it recovered a few weeks later. Of course, this happened inside a bear market that started in 2000 and didn’t end until 2003.

stock market v recovery september 11 9:11

Is this so different than 9/11? Of course, it is. Every new moment is always different. But, we’ve experienced these things before. I was much more of a rookie 20 years ago when I walked into my investment firm office to see the planes hit. It was an incredibly emotional and panicked time in American history. At the time, it wasn’t just the one attack, we wondered what would be next. It was the Pentagon, and another plane was hijacked. We didn’t know what to expect, it was uncertain. When would we be attacked again? Where? Would it wipe us out?

We didn’t know.

Portfolio managers and tactical traders must be here, now, in the present moment, not dwelling on the recent past, there will be time for that later when things are calm and quiet. But even then, we can’t do anything in the past, we can only do it now.

I hope this helps.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

 

Wrong narrative? Feeling the Bern of socialism may have been even scarier

Yesterday, after the “emergency” interest rate cut by the Federal Reserve, the US stock market trended down to close -2.8%.

Top news headlines looked like this:

fed rate cut march 2020

They were rather alarming, the largest since the financial crisis, and “emergency cut” and “to combat virus fear.”

What if much of the selling pressure in the stock market has been more by “Fear the Bern” more than coronavirus? Stock index futures are up about as much as they fell yesterday after Joe Biden beat Bernie Sanders on Super Tuesday.

stock market feared bernie sanders fear the bern

Prior to last night, Sanders appeared highly likely to secure the nomination; the odds plunged from 65% to 16% now.

You may consider the possibility large stock market investors were more concerned about the recent Bernie Sanders lead over Joe Biden than coronavirus.

Feeling the Bern of socialism may have been even scarier. 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

Investor sentiment and feelings can be data-driven, quantitative, applying the scientific method, supported by a mathematical basis for feeling and believing

Investor sentiment and feelings can be data-driven, quantitative, applying the scientific method, supported by a mathematical basis for feeling and believing

Individual investors are notably less bearish now, according to the AAII Sentiment Survey.

US Investor Sentiment, % Bearish is an indicator that is a part of the AAII Sentiment Survey. It indicates the percentage of investors surveyed that had a bearish outlook on the market. An investor that is bearish, will primarily believe the US stock market will trend lower in the next six months.

Bearish US Investor Sentiment dropped 25%, so only 26.4% of the investors surveyed expect the stock market to fall in the next 6 months. Bearish sentiment is now below its average over the past year, but far from an extreme reading. I marked the high, low, and average on the chart.

Investor Sentiment less bearish

The most extreme level of bearish sentiment historically going back to 1989 is all the way down to only 6% Bearish, which we haven’t seen since 2003.

bearish extreme sentiment

If you notice, the Bearish level has held a higher low the past decade. That is, recent stock market peaks haven’t resulted in those extreme lows since the investor survey started 22 years ago. So, behavior and sentiment surveys aren’t an exact science, nor are they intended to be. Below we see a Bearish level of 20% has been the common low in Bearish sentiment.

bearish investor sentiment signal

I could put the data into a table format and show a mode analysis, which is a study that shows when Bearish sentiment spikes or falls, what happens to the stock market. Since I apply the scientific approach to trends and cycles, I have certainly tested the indicators I observe scientific for quantitative analysis. I require a mathematical basis behind believing what I believe. If it doesn’t test out mathematically using the scientific approach, it would be of little use. To know what is of use, or not, requires quantitative testing. I don’t share my quant work, but instead, prefer to show observations of the trends in the data. When presenting my research, I do so visually.

In the chart below I overlay the % Bearish sentiment in orange over the S&P 500 % off high (the drawdown) in purple. We can visually see how they interact with each other. As the stock market falls, Bearish investor sentiment % spikes up. I highlighted these times.

stock market drawdowns bearish sentiment

Investors become more afraid of falling prices after they fall. Investors also extrapolate the recent past into the future, so they expect falling prices to beget further falling prices. We can hypothesize this because investors are more Bearish at lower prices, less so at higher prices.

Okay, so far I’ve only shown the Bearish sentiment.

What about Bullish investor sentiment? 

US Investor Sentiment, % Bullish is a gauge of the AAII Sentiment Survey. It registers the percentage of investors surveyed that had a bullish outlook on the market the past week. An investor that is bullish, will primarily believe the market will trend higher in the next six months.

US Investor Sentiment, % Bullish increased 41.33% the week of February 13, 2020. The % Bullish investor sentiment was the most notable change over the last week. Individual investors are notably more Bullish. However, although the Bullish sentiment is well above the average of the past year, individual investor enthusiasm isn’t yet at the highest level reached over the past year, which I marked in the chart.

bullish investor sentiment 2020

Meanwhile, the Fear & Greed Index, driven by 7 market sentiment indicators, is Neutral.

cnn fear greed index predictive

So, while individual investors are becoming more bullish about the stock market trend for the next 6 months, they haven’t quite yet reached an extreme level that often signals buying enthusiasm is becoming exhausted. But, the rate of change in Bullish investor sentiment is worth making note of for situational awareness as investors usually believe and do the wrong things and the wrong time at extremes.

coronavirus headlines

So far, the US stock market has been resilient, especially considering the headlines have been dominated by the virus updates and images of people around the globe bearing masks.

“When the facts change, I change my mind. What do you do, sir?”

John Maynard Keynes

I’ve kept more of my market risk hedged-off than I’d like (in hindsight) if market prices don’t fall to a lower-risk point, but we’ll see how it unfolds from here.

My edge is discipline and my tactical decisions are completely intentional and come from a fully committed state, so I don’t fear losing money or missing out. I tend to feel the right feeling at the right time, as my feelings are data-driven, quantitative, applying the scientific method, supported by maths for a mathematical basis for feeling and believing. Oh, and a heavy dose of stoicism.

I also change as the facts do, and the only facts that ultimately matter are price trends.

Have a Happy Valentines Day and weekend, friends!

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

Global Macro: My favorite economic chart, consumer sentiment, and debt

People typically share their opinions based on their own personal observations of what they see and hear going on around them.

What we believe is always true, for us.

An advantage of a quant, or quantitative analyst, is the ability to study the data and trends to observe what is really doing on.  Data science is an interdisciplinary field that uses scientific methods, processes, algorithms, and systems to extract knowledge and insights from structured and unstructured data. Then, we get to see how it compares to our own unique observations.

A friend of mine who happens to be a business broker helping people buy and sell businesses commented he thinks the next big recession will be caused by consumer debt. As we discussed it a few minutes, his opinion was based on his own observation that it seems the people around him are living “high on the hog” as we say it down South. In other words, people are taking on heavy debt and spending what they earn rather than saving and investing.

I can see why he may perceive it that way if your neighbors have a fleet of newly leased luxury cars in the driveway and seem to be taking vacations beyond what you believe they can afford. In some cases, if not many, it may be true their personal debt to income ratio may be maxed out. They may be buying cars, boats, and trips instead of saving and investing their excess earnings.

But, everything is relative.

Sometimes when things are good people want to take some extra chips and reward themselves. In fact, some of the greatest rainmakers I have known do this very thing. Many hard-charging producers of wealth also enjoy the rewards from their work.

Some of us get as much satisfaction from seeing our investment accounts grow from investing our excess earnings. Maybe we are more Introverts, so motivation comes from within, rather than impressing others. But that doesn’t mean we don’t enjoy the fruits of our labor. As everything is relative, we may be only eating a slice of an apple from a cart of dozens. But, for those who don’t have dozens of apples, it may seem more.

It’s an illusion of asymmetric insight, which is a cognitive bias whereby people perceive their knowledge of others to surpass other people’s knowledge of them.

Others are more extroverted and willing to spend all of their money in the present moment, rather than plan for the future. In this case, they may spend their earnings as fast as they get it, so there is no “excess” earnings to worry about. I suppose if you spend it all, you’ll have less stress about investing it, but you’ll be on the treadmill forever. While those who spend all of their earnings don’t have to concern themselves with the capital markets and investment management, they may not sleep well at night with all the uncertainty the lack of a secure future can bring. But, some of them may not think that far and not worry about it at all.

Consumer sentiment also has a role in how we all spend our money. When people are optimistic about the future, we are more willing to spend. There are infinite factors that drive sentiment, rational or not. For example, with a great credit score, you could get a car loan at 2% for years and such a low rate of cost to borrow may be more enticing to buy new cars. Even wealthy investors will take advantage of low rates since it doesn’t require withdrawing from investment funds and the borrowing cost is minimal. We can say the same for mortgage rates. The wealthiest of investors probably achieved it with some level of leverage. For example, business owners may use debt early on to grow their company and then when they sell it, it may either be debt-free or the net capital gain is much higher than it would have been without using the leverage to grow. Some use of debt or leverage can be good and it’s even essential in some areas such as real estate to maximum return on equity.

So, on the topic of debt, rates, savings, and such, here are some charts of the data.

First, let’s look at consumer sentiment. The US Index of Consumer Sentiment from the University of Michigan tracks consumer sentiment in the US, based on surveys on random samples of US households. The index aids in measuring consumer sentiments in personal finances, business conditions, among other topics.

Take out the 1999 euphoric period and consumer sentiment by this measure is about as high as it gets.

consumer sentiment michigan

Historically, the index displays pessimism in consumers’ confidence during recessionary periods, and increased consumer confidence in expansionary periods. So, in the next chart, we highlight recessions in gray.

consumer sentiment recessions

Does consumer spending match consumer sentiment?

As consumer sentiment is relatively high, spending as measured by US retail sales is at an all-time high. I note some divergence since around 2017 as sentiment has remained elevated but cycling up and down mostly above its average as retail sales trends up.

consumer spending sentiment retail sales global macro trend

Employment and interest rates are a drive of these global macro trends. I observed in Employment, Coronavirus, it’s just the market, doing what it does… that unemployment is at historic lows. When most people who want to work are working that’s probably helping consumer sentiment. Gotta love such low unemployment! But, as a risk manager, we also use it as a reminder of situational awareness since nothing lasts forever.

US UNEMPLOYMENT RATE

What about the savings rate?

This is one of my favorite non-market global macro trend charts. Total savings is trending up.

savings rate consumer sentiment

Aside from employment, some other drivers of consumer sentiment are probably the trend and level of retail gas prices, auto loan rates, credit cards, home equity lines of credit, and mortgage rates. While we much prefer to see our fellow American’s use less debt, relatively low rates make borrowing more attractive. Again, some of the wealthiest families may even borrow at low rates and keep their capital invested. So, debt isn’t just borrowing because they can’t afford it otherwise.

The US Retail Gas Price is the average price that retail consumers pay per gallon, for all grades and formulations. Retail gas prices are important to view in regards to how the energy industry is performing. Additionally, retail gas prices can give a good overview of how much discretionary income consumers might have to spend.

We’ve enjoyed some relatively low gas prices for the past five out of ten years. You may have noticed it at the pump or observed the lack of gas price headlines.

gas price past 10 years

I first showed the more recent period to point out we tend to have recency bias, as we weight the most recent experience the most. It’s a “what have you done for me lately” kind of mindset.

Next up is the longer-term trend in retail gas prices. I marked the high and low along with the average gas price going back to 1990.

gas price trend long term trend following

While the retail gas price has been elevated above average, it’s far from the highest levels of the past.

Is there really causation here between the price of gas and consumer sentiment?

There has been a negative correlation between the price of gas and consumer sentiment, so yes. I’ll say they are related the past decade in that a down-trending gas price helped drive up consumer sentiment.

gas price consumer sentiment negative correlation

I’m going to save some interest rates for another observation, so next up is my favorite chart.

The Federal Reserve Board’s Household Debt Service and Financial Obligations Ratios convey how much of US household income is being spent on repaying debts and mortgages. It includes data specific to renters and homeowners. The homeowner data includes income spent on automobile lease payments, property taxes, and homeowner’s insurance.

US Household Debt Service as Percent of Disposable Income and US Household Consumer Debt Service as a Percent of Disposable Income are both at relatively low levels. Debt service is about as low as it’s been. Consumer debt service is below average. 

consumer debt as percent of disposable income

So, in the big picture, my friend is wrong. The consumer debt situation is better than it may seem.  By and large, this trend tells us our fellow American’s aren’t nearly as in debt as they were 10 to 15 years ago and overall, have less debt to disposable income than they’ve had in decades.

So, hopefully, in the next recession, American’s won’t have such a difficult time from being upside down drowning in their debt.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Employment, Coronavirus, it’s just the market, doing what it does…

It seems most people probably believe the news drives the stock market.

I can see why, since the news headlines want to tell a story.

We like a great story. We want to hear the narrative. We definitely want to believe we know the causation of things going on around us.

Do you believe the news drives stock price trends?

Coronavirus Live Updates: Trump Praises China’s Response to Outbreak as Death Toll Passes 600 – New York Times 

The Coronavirus outbreak in Wuhan China has grown exponentially as asymmetric uncertainties usually do. According to Worldometer, there are now 31,535 of which 4,826 (15%) in critical condition 638 deaths and 1,778 have recovered. 
number of Coronavirus Cases
The Coronavirus outbreak only started less than a month ago, but its rate is exponential.
coronavirus total cases deaths
This is not the kind of asymmetry we want to observe. I hope a cure is found soon to save these human lives.
How has the stock market reacted?

The S&P 500 gained over 3% the past 5 days anyway… 

spy spx trend following etf

It’s just the market… doing what it does…

This morning, in the U.S. we get great news on employment data.

The US Unemployment Rate measures the percentage of total employees in the United States that are a part of the labor force but are without a job. It’s one of the most widely followed indicators of the health of the US labor market and the US economy as a whole. Historically, the US Unemployment Rate reached as high as 10.80% in 1982 during a notable recessionary period.

The low Unemployment Rate has been a bright spot for the U.S. economy since unemployment trended up sharply in 2008 and peaked at 10.10% in November 2009, the highest level since ’82. A picture is worth a thousand words, so here the trend. from January 2007 to November 2009 as Unemployment Rate increased sharply from 4.4% to 10.10% in about two years.

us unemployment peak 2008 2009

Looking at the US Unemployment Rate in the bigger picture, below are the trends and cycles going back over sixty years. US Unemployment Rate is at 3.60%, compared to 3.50% last month and 4.00% last year. This is lower than the long term average of 5.73%. The last recession was the second-highest unemployment and it has recovered even smoother than before.

US UNEMPLOYMENT RATE

The headlines today:

January adds a much stronger-than-expected 225,000 jobs, with a boost from warm weather” – CNBC

The stock indexes are down over -0.50% anyway…

I say: It’s just the market, doing what it does… 

I believe investors underreact and overreact to new information “news.”

An overreaction is when price trends become overbought or oversold driven by psychological and investor sentiment reasons rather than fundamentals. It’s why we see crashes and bubbles, over short term and long term periods.

An underreaction is when investors initially underreact to new information such as earnings announcements, which leads to a predictable price drift. In other words, underreaction drives price trends!

Prices drift up or down over time when investors underreact to information.

Prices overshoot, trade up or down too far, too fast, when investors overreact to information.

This why my focus is on the direction of price trends, along with volatility, investor sentiment, and multiple time frame momentum.

My directional trend following systems are designed to catch the trends that drift from underreaction.

My countertrend systems signaled by momentum, extreme investor sentiment, and volatility analysis, are engineered to capitalize on overreactions.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

Investor sentiment shifts

We’ve seen a notable shift in investor sentiment.

AAII Sentiment Survey:

Pessimism surged to its highest level in more than three months, while optimism plunged. Plus, this week’s special question asked AAII members to share their thoughts about the S&P 500’s low volatility.

aaii investor sentiment

With the data, I drew a chart to see how bullish and bearish sentiment oscillates in cycles and the notable drop in optimism and spike in fear.

investor sentiment before coronavirus

The bull-bear spread chart has reversed down below its average level of the past year.

bull bear spread chart aaii sentiment

The Fear & Greed Index made up of seven different sentiment indicators is neutral now, down from Extreme Greed a month ago.

fear greed index analysis backtesting investor sentiment

One of the seven indicators is Safe Haven Demand.

Stocks and bonds have provided similar returns during the last 20 trading days. However, this has been among the weakest periods for stocks relative to bonds in the past two years and indicates investors are fleeing risky stocks for the safety of bonds.

safe haven demand

The Put-Call Ratio is another showing fear.  It is still among the highest levels of put buying seen during the last two years, indicating extreme fear on the part of investors.

So, it seems it only took a -2.6% drop to shirt investor sentiment from extremely bullish to more bearish and neutral.

bearish sentiment

We’ll see how it goes from here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Investor sentiment is dialed up with stock trends

I believe there are many factors that drive stock prices and one of them is investor sentiment. However, enthusiasm and panic can also reach extremes, which drives the opposite trend.

When investors are extremely bullish they help drives up as long as they keep buying stocks. But, at some point, their buying enthusiasm or capacity to buy gets exhausted and the buying pressure dries up. We saw this in rare form in 2017 as investor sentiment was excessively bullish as prices kept trending up. In the chart below I show the breakout after a very volatile period (yellow) and a smooth uptrend in 2017 (green line), but then it was interpreted sharply early 2018 and then corrected even more by the end of ’18.

trend following breaktout uptrend 2017 crash 2018 asymmetic returns risk reward

In fact, as an example of the challenge of this period, if we had applied a trend following system that entered the breakout above the 2015-16 trading range and but didn’t exit at some point in the uptrend, this stock index declined all the way back to the breakout entry point. SPX trading trend following breaktout uptrend 2017 crash 2018 asymmetic returns risk reward

We can say the same for buy and hold; if someone held stocks over this period the end of 2018 they were looking back three years without much capital gain. So, the point in time investors decide to do their lookback makes all the difference.

Back to investor sentiment…

Another observation about investor sentiment is after prices trend up, investors get more and more optimistic about prices trending up, so the trend and momentum itself attract stock buying enthusiasm. At major bull market peaks, like in 1999, it brings out the masses. I remember grandmothers cashing out bank CD’s wanting to buy stocks then.

The same applies on the downside. After prices fall, investors become more and more afraid of deeper losses in their portfolio, which results in more selling pressure.

Everyone has an uncle point, it can either be predefined like mine is, or you can find out the hard day after your losses get large enough you tap out at lower prices. 

Since I shared my observations of investor sentiment in You probably want to invest in stocks last week, the CNN Fear & Greed Index, made up of 7 investor sentiment indicators, remains dialed up to “Extreme Greed”, so investors and the market seem to be optimistic about up-trending stock prices.

Fear and Greed Index

In fact, based on the historical trend cycle of the CNN Fear & Greed Index the market seems to be as optimistic about up-trending stock prices as it’s been in years. Only late 2017 did we see as much enthusiasm.

Fear and Greed over time

Who remembers how that turned out?

2018 Drawdown in stocks loss

On sentiment indicator, I noted last week that wasn’t as bullish as others were the AAII Individual Investor Sentiment Survey. That changed this week.

US Investor Sentiment, % Bull-Bear Spread is at 14.33%, compared to 3.17% last week and 9.09% last year. This is higher than the long term average of 7.72%. investor sentiment chart bull bear spread

So, individual investors are bullish, according to AAII.

What’s driving all this enthusiasm for the stock market?

The trend is up, and here is a chart of the S&P 500 market capitalization showing the value of the stocks in the index based on the current price.

S&P 500 market capitalization cap history

Most investors follow trends whether they realize it or not. Trend following can be a good thing as long as the trend continues. It’s when the trends change we find out who’s who.

You can probably see why I believe it is essential to actively manage investment risk and apply robust drawdown controls to avoid the bad ending. For me, it’s a combination of predetermined exits to cut losses short and asymmetric hedging.

 



Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

You probably want to invest in stocks

You probably want to invest in stocks right now, I bet.

If you are already invested in stocks, you probably want to be more aggressive in investing in stocks. Maybe it’s selling bonds to buy more stocks, or investing that extra cash, or something really aggressive like adding leverage or buying more risky stocks.

I believe this because investor sentiment is dialed up and 2020 started out about as enthusiastic as it gets. Well, and we’re getting calls from people wanting to invest.

fear greed index

The Fear & Greed Index is driven by seven different investor sentiment indicators. If you’re an investor, I encourage you to use it as a gauge for your own enthusiasm and panic.  When you feel one way or another about the future direction of the stock market, check the indicator to see what emotion is driving the stock market now.

Avoiding costly mistakes is essential in money management, so if we can help you avoid buying too high and then tapping out at the lows, that’s an edge. That’s the behavioral counseling we do; investor behavior modification. It’s one of the main observations I share here. If nothing else, I hope I can help you avoid making costly emotional decisions as many investors do.

The Options Speculation Index measures speculative call buying as a % of total option activity. Right now, it shows the options market bought to open 21.6 million speculative call options, the most ever, according to SentimentTrader. The previous record was 19.7 million during the week of Jan 26, 2018. The total bullish/bearish volume was the most since March 2000. This is extreme.

options speculation index

Investors sentiment trend to follow price trends, so investors or trend followers.

After prices trend up, investors get more bullish, expecting the gains to continue.

After prices trend down, investors get more bearish, expecting the losses to continue.

So, it isn’t a surprise to see this level of enthusiasm, considering the stock index is at an all-time high.

stocks stock market at all time high

The AAII Investor Sentiment Survey is a another gauge that offers insight into the mood of individual investors. Each week, AAII asks its members a simple question: Do they feel the direction of the stock market over the next six months will be up (bullish), no change (neutral) or down (bearish)? They refer to this question as the AAII Sentiment Survey. Since they started polling members in 1987, our survey has provided insight into the moods of individual investors.

aaii investor sentiment

Pessimism among individual investors about the short-term direction of the stock market is at a six-week high. The latest AAII Sentiment Survey also shows lower levels of bullish and neutral sentiment. Below is a chart I drew of the % Bearish sentiment from the survey with a line marketing its long-time average. Investors are not bearish, as the level is at its long term average. So, this gauge doesn’t match the Extreme Greed of the Fear & Greed Index. 

US Investor Sentiment, % BEARISH

The % Bullish is actually below average by this measure. Bullish sentiment, expectations that stock prices will rise over the next six months, fell 4.1 percentage points to 33.1%. The historical average is 38.0%. Optimism has been below this average during 41 out of the last 52 weeks.

US Investor Sentiment % Bullish

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 3.9 percentage points to 37.0%. Even with the drop, neutral sentiment is the expectation that is above its average of 31.5% for the 33rd time in 34 weeks.

 

investor sentiment for trading

AAII guesses:

The killing of Iranian general Qasem Soleimani likely influenced this week’s results. Several respondents brought up the conflict with Iran and tensions in the Middle East. Also affecting sentiment are the trade agreement between the U.S. and China, Washington politics, earnings growth, the economy, valuations and the stock market’s recent record highs.

This week’s special question asked AAII members: what you think will most influence the direction of stock prices in 2020?

Approximately 39% of respondents believe that geopolitical events will have the most influence on stock prices in 2020.

Individual investors have a lot of opinions based on news:

Unsurprisingly, the ongoing conflicts with Iran and China are named specifically. Domestic politics are also named by many respondents, with 26% stating that the outcome of the November elections will most likely influence the market. Additionally, 18% of respondents from this survey believe that earnings performance will sway the stock market and 17% say that the Federal Reserve’s policy and a low-interest-rate environment will have the biggest influence on how the stock market will move in 2020.”

Here is a sampling of the responses:

“The economy and earnings. And maybe an end to some of the trade wars.”

“The Fed will need to continue to lower rates and will probably need to continue its easing to maintain liquidity in overnight lending.”

“Strong business cycle in the U.S. and better trade agreements with China.”

“Earnings versus forecasts.”

“Conflict in the Persian Gulf and the 2020 election will increase uncertainty.”

In my opinion, these individual investors focus on the wrong things. The direction, momentum, and volatility of the price trend are all the matters. The direction of the price trend is the final arbiter. 

Is the AAII Sentiment Survey a Contrarian Indicator?

To learn more about the survey and the opinion of Charles Rotblut, who is vice president at AAII and editor of the AAII Journal on the matter, read the article by the same name: Is the AAII Sentiment Survey a Contrarian Indicator? 

Here are his conclusions in sentiment insights and as its role as a potential contrarian indicator for market direction.

“As the data shows, extraordinarily low levels of optimism have consistently preceded larger-than-average six- and 12-month gains in the S&P 500.”

It goes on to add:

“Sentiment is not a flawless contrarian indicator, however. Though unusual, bullish and bearish sentiment readings above or below one standard deviation from their historical average have a mixed record of signaling market direction. Extraordinarily high bullish sentiment and extraordinarily low bearish sentiment (two standard deviations away from the average) have generally worked well, with the exception of two notable periods.”

“It will be many years before we know whether the periods of 2003–2004 and November 2007–February 2009 were mere blemishes on the survey’s record as a contrarian indicator or a sign that both optimism and pessimism can remain at high levels for an extended period of time. I tend to think the latter will be the case, given long-term market history.”

Two important conclusions:

The failure of sentiment to work perfectly highlights two important points. Though correlations between sentiment levels and market direction have appeared in the past, the AAII Sentiment Survey does not predict future market direction. Overly optimistic and pessimistic investor attitudes are characteristics of market tops and bottoms, but they do not cause stock prices to change direction. Rather, it is changes in expectations of future earnings and economic and valuation trends that move stock prices. The timing of such changes has proven to be difficult to predict with accuracy.

This leads to my second concluding point: Never rely on a single indicator when forecasting market direction. Rather, consider a variety of factors—including prevailing valuations, economic data, Federal Reserve policy, government policies and other prevailing macro trends—and allow for a large margin of error in your forecast.:

As the saying attributed to John Maynard Keynes goes, “the market can stay irrational longer than you can stay solvent.”

As many studies like Dalbar show; individual investors have difficulty achieving good results over the long term, so they must be focused and doing the wrong things.

“Since 1994, DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term timeframes. These effects are measured from the perspective of the investor and do not represent the performance of the investments themselves. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.”

None of the global macro news items they listed can possibly be predicted, so it is futile. So, if investors using this type of information for investment decision making, you can probably see how they may end up “switching in and out of mutual funds” at the wrong time.

By focusing on the price trend and its statistical possibilities and actively managing risk and drawdown, I believe we stack the odds in our favor by focusing our resources on the few things we can control.

Is it a good time to buy stocks? That’s my next observation as I’ll share the big picture.

Got questions? need help? Send me an email here.



Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Keeping the mind right with investor sentiment indicators

Investors oscillate between the fear of missing out and the fear of losing money.

After their portfolio trends up, they extrapolate recent gains into the future.

After their portfolio falls, they extrapolate recent loss into the future, expecting the damage to continue.

Investors mostly follow the trend, and this extrapolation bias helps to drive price trends.

Of course, not every investor follows the trend. Some are more fearful all the time, others are more optimistic, but I believe most oscillate between the fear of missing out and the fear of losing money.

The fear of missing out happens when they hear the stock market has made significant gains, and they don’t have the same exposure to it. Not enough exposure could mean 100% exposure to stocks, or it could mean leverage for aggressive investors and traders. The fear of missing out sucks them in, often at the wrong time. They’ll almost always feel this way after the fact when it’s too late.

As Walter Deemer says:

“When The Time Comes To Buy, You Won’t Want To” 

The fear of losing money happens when the investment portfolio is falling, and investors extrapolate the losses into a fear of losing more money. Since not all of us are trend followers, some will fear loss after significant gains, expecting a countertrend.

Regardless of whether an investor’s behavior is more driven by trend-following or countertrend expectations, they all seem to oscillate between the fear of missing out and the fear of losing money.

We quantify this investor sentiment into indicators that may be used as signals. Two examples are the Fear & Greed Index and the AAAI Investor Sentiment Survey.

The AAII Asset Allocation Survey turned bullish again last month, with investors saying they have more capital allocated to stocks.

AAII allocation survey bullish

However, neutral investor sentiment is at the upper end of its historical range, suggesting investors are indecisive. They’ll turn bullish if stocks continue to trend up. They’ll get bearish if stocks trend down.

neutral investor sentiment at uppper end of range AAII

Instead of polling the AAII members to crowdsource by for their opinions, the Fear & Greed Index gauges sentiment from seven different indicators.  The Fear & Greed Index had shifted down from Extreme Greed to a more moderate Greed back to Extreme Greed. Again, following the price trend as stocks fell, so did their enthusiasm.

fear and greed index

Below is a visual of the Fear and Greed over time. You can probably see some evidence of my observation that investors oscillate between greed and fear in cycles. Although most of this data is in the middle of the chart, it also reaches extremes. It’s the extremes I pay attention to as both a countertrend signal and also to help investment management clients with behavior modification. Most of the time I want to follow the trend, but at the extremes is when I may deviate from the crowd.

fear and greed index over time

It isn’t enough to be a successful investment manager, we also have to help clients modify their behavior. Most people simply tend to do the wrong thing and the wrong time, and I believe the edge is avoiding that enough so that my average gains far exceed my average losses – that’s ASYMMETRY®. But, even if we create consistently upward sloping asymmetric investment returns, it isn’t enough without keeping the mind right.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

A volatility expansion seems imminent

On November 16th, about two weeks ago, I shared an observation in “Periods of low volatility are often followed by volatility expansions” that implied and realized volatility had reached such a low level we should expect to see a volatility expansion.

I also pointed out investor sentiment had been reaching excessive optimism. The type of excessive optimism we normally see when less-skilled investors have an urge to buy stocks instead of a hedge or sell them to reduce risk.

It was plenty early, as expected, which is better than being late.

When I share these observations, the intent is to highlight an extreme trend or cycle I expect to shift the other direction. In this case, I saw the range of prices was getting tight, suggesting to me there was little indecision in the market, which also implies confidence and complacency.  I say this, having been monitoring these market dynamics daily and professionally for over two decades.

The chart I included showing the S&P 500 price trend peaking at the upper band of its range and its average true range at what I consider an extreme low go included in MarketWatch, then Barron’s, and then today The Daily Shot in the Wall Street Journal.

Mike Shell Wall Street Journal WSJ

Since that chart is now two weeks old, here’s an update. The S&P 500 has trended down about -1.2% the past two sessions and its price is back inside the volatility bands. However, notice the bands have contracted since October, so I say again: Periods of low volatility are usually followed by volatility expansions.

volatllity expansion vix asymmetric december 2019

So, stay tuned, a volatility expansion with at least a minor price correction seems imminent.

Prepare yourself accordingly.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The use of this website is subject to its terms and conditions.

By and large, the stock market is correlated with consumer sentiment

I’ve shared some observations about investor sentiment this past week as sentient indicators and surveys have reached an extreme level of optimism.

When sentiment reaches an extreme, we should prepare for it to swing the other way, at least temporarily.

Why?

Because that’s what it does. Most financial and economic data cycles up and down, swinging like a pendulum as investors oscillate between fear and greed. Or, as I like to put it: oscillating between the fear of missing out and the fear of losing money.

What about consumer sentiment?

The US Index of Consumer Sentiment is another sentiment survey, but it measures consumers instead of specifically investor sentiment about the stock market trend. The US Index of Consumer Sentiment (ICS), as provided by University of Michigan, tracks consumer sentiment in the US, based on surveys on random samples of US households. The index aids in measuring consumer sentiments in personal finances, business conditions, among other topics. Historically, the index displays pessimism in consumers’ confidence during recessionary periods, and increased consumer confidence in expansionary periods.

US Index of Consumer Sentiment is at a current level of 95.70, an increase of 0.20 or 0.21% from last month. This is a decrease of 1.80 or 1.85% from last year and is higher than the long term average of 86.64.

US consumer sentiment is near the top of its historical range going back decades. There are only two times since its inception the level was high than it is now, such as the euphoric bubble of the late 1990s.

Consumer sentiment has been trending up the past decade until 2015 and has been drifting sideways at the historical peak range the past four years.

The art of contrary thinking suggests when everyone thinks alike, everyone is likely to be wrong. However, in recent years the crowd has been right. For example, US GDP (Gross Domestic Product) is the total value of goods produced and services provided in the US. It is an indicator to analyze the health of the US economy. GDP is calculated as the sum of Private Consumption, Gross Investment, Government Spending, and Net Exports. Two-quarters of consecutive negative real GDP growth is considered a recession. GDP is also used by the Fed (FOMC) as a gauge to make their interest rate decisions. In the post World War II boom years, US GDP grew as high as 26.80% in a year, but by the late 20th century 2-7% nominal growth was more the norm.

US GDP is at a current level of 21.53 trillion as of September, up from 21.34 trillion in the last quarter. This represents a quarterly annualized growth rate of 3.48%, compared to a long term average annualized growth rate of 6.26%. Although it shows the US economy has grown less than the long term average, the United States is now a developed country and long past the emerging country stage pre-WWII boom years. So, in the chart below we observe a correlation between consumer sentiment and GDP. Up until recently, they are trending in the same direction, but keep in mind GDP doesn’t necessarily have an upside limitation, while the consumer sentiment is a survey that can be more range-bound. Sentiment surveys tend to oscillate up and down in response to changing economic conditions.

Another note about GDP before I get a thousand emails from my economics friends and other global macro funds managers, US Real GDP Growth is measured as the year over year change in the Gross Domestic Product in the US adjusted for inflation. To make my point and keep it simple, I used the base GDP.

So, how does overall consumer sentiment correlate with the stock market trend and how do they interact with each other?

Below we chart the US Index of Consumer Sentiment overlayed with the S&P 500 price trend for general visual observation. By looking at the lines, we can observe they are correlated. Up to 2000, the stock market and consumer sentiment trended up. The stock market and consumer sentiment trended down from 2000 to 2003 or so.

But, from around 2003 to 2008 it would appear consumer sentiment was non-trending as it drifted sideways as the stock market trended up, however, the sentiment was just staying at its peak level. When I highlight the peak range below, it’s more obvious that sentiment remains at a high level for years and occasionally swings down. Americans are mostly optimistic about America! and we should be.

consumer sentiment correlation with the stock market intermarket analysis

Continuing to review the trends, the period from 2007 on is correlated again to the downside as stocks and consumer sentiment dropped sharply. Recall this stock index declined -56% from October 2007 to March 2009 and then took four years to reach its 2007 high again in 2013. We can see the bottom chart above is the correlation coefficient of these two data. Although the correlation oscillates up and down, it has remained in the upper range signaling it is more correlated that not.

The larger declines in consumer sentiment are related to recessions. We’ve only had two recessions since 1991. The 1990s was the longest period of economic growth in American history. The collapse of the speculative dot-com bubble, a fall in business outlays and investments, and the September 11th attacks, brought the decade of growth to an end. Notwithstanding these major shocks, the recession was relatively brief and shallow compared to the one we would see seven years later. I marked the recessions in gray to show how they fit into the big picture.

“As a general rule, it is foolish to do just what other people are doing, because there are almost sure to be too many people doing the same thing.”

William Stanley Jevons (1 September 1835 – 13 August 1882) was an English economist and logician. Irving Fisher described Jevons’s book A General Mathematical Theory of Political Economy (1862) as the start of the mathematical method in economics.

This is really about human behavior.  Emotions and sentiment rise and fall with events.

To be a successful investor over the long term, we must necessarily believe, feel, and do differently than the masses at the extremes. So, I monitor the extremes to see when they change. At the extremes, I hope to be doing the opposite of what our investment management clients and everyone else believe I should be doing. 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The use of this website is subject to its terms and conditions.

Can an optimistic investor sentiment measured by the AAII Investor Sentiment Survey trend higher?

Someone asked:

Can an optimistic investor sentiment in AAII Investor Sentiment Survey trend higher?

Another commented:

The AAII Investor Sentiment Survey is just over its long term average, so it has room to run.

Of course, bullish investor sentiment can trend higher. That is especially true when looking at just one survey measure like the AAII Investor Sentiment Survey.

Below I charted the Investor Sentiment, % Bearish and % Bullish using the AAII Investor Sentiment Survey data. Looking at the extremes, the end of 2017 was the highest % Bullish and the lowest % Bearish. If you recall, it was a very euphoric period with stocks trending up.

For another less noisy visual of this observation, I then chart the % Bullish – Bearish Spread. When it’s higher, more investors taking the survey are bullish. When it’s lower, more are bearish.

The peak optimism is clearly shown at the end of 2017 after the stock market had trended up with abnormally low volatility.

The peak cycle in pessimism was last December 2018, after stock prices had a waterfall decline.

To be sure, next, we overlay the % Bull-Bear Spread over the S&P 500 stock index. We can see visually the % Bullish reached an extremely high level in the last month of 2017 as the stock index trended up.  But, what happened afterward? aaii investor sentiment survey research backtesting

We see its lowest level over the period was the end of 2018 as stocks were in a waterfall decline.

The key is; what happened after the extreme level of bullishness?

It continued for a while, but I warned about it on January 24, 2018:

By the way, this past year is vastly different than the low volatility period I highlighted above. I was pointing out the stock index hadn’t dropped more than -4% in over a year and that was an unusually quiet condition. This past year has been more normal-looking from that perspective, with tow -5% – 7% drops after the waterfall.

Below is the trend from 2015 to 2018 to put it into perspective. Preceding 2017 were those two declines in 2015 and 2016. The beginning of which was considered a “flash crash.”

After stocks reached the second low, the trend up became smoother and smoother. Oh yeah, another blast from the past; I pointed that out, too, in November 2017.

Below is the trend from the January 26, 2018 peak through December 2018. The S&P 500 stropped -18% and more like -20% from the recovery high in October 2018 before the waterfall decline.

Here is the trend from January 1, 2017, to December 25, 2018. It’s what happened after the euphoric period. It was all but wiped out just a few months.

Can the investor sentiment get even more optimistic and drive stock prices even higher? Of course, it can! It has before! The Bull-Bear Spread is elevated, but not at its historical extremes.

But the AAII Investor Sentiment Survey isn’t necessarily a timing indicator by itself. It’s just a gauge. But, when combined with other observations I’ve discussed this week, the weight of the evidence suggests it’s a better time to reduce risk and hedge than to take on new risks as these surveys show investors are doing.

Those who forget the past are doomed to repeat it. 

Those who learn from the past have the potential to gain an edge from it.  

Have a great weekend!

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The use of this website is subject to its terms and conditions.

Investor optimism is reaching extremes

Ok, so this isn’t anything new. I just discussed it last week in “Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback.” The sentiment indicators keep confirming the same signal: that investors are very optimistic about future gains.

It’s the kind of sentiment we often see before a decline.

The Fear & Greed Index is a simple combination of seven different indicators that are considered investor behavior measures. It includes the Put/Call Ratio, the net new 52 week highs and lows, stock price breadth, market momentum, the yield spread between junk bonds and investment-grade, and market volatility.  It’s a useful gauge to monitor against your own sentiment and behavior. The Fear & Greed gauge remains at a high level, signaling “Extreme Greed” and excessive optimism.

Fear & Greed Index What emotion is driving the market now?

Just as the stock market cycles up and down over time, so does investor sentiment. In fact, I believe investor sentiment oscillating between fear and greed is what drives stocks in the short run.

We measure this investor behavior with these different indicators. For example, the number of stocks hitting 52-week highs exceeds the number hitting lows and is at the upper end of its range, indicating extreme greed. The S&P 500 is 4.90% above its 125-day average is another above the average than has been typical during the last two years and rapid increases like this often indicate extreme greed.

The Put/Call Ratio shows during the last five trading days, volume in put options has lagged volume in call options by 50.13% as investors make bullish bets in their portfolios. This is among the lowest levels of put buying seen during the last two years, indicating extreme greed on the part of investors.

Stocks have outperformed bonds by 4.50 percentage points during the last 20 trading days. According to the Fear & Greed Index, this is close to the strongest performance for stocks relative to bonds in the past two years and indicates investors are rotating into stocks from the relative safety of bonds.

Junk bond demand shows investors in low-quality junk bonds are accepting only 1.84% in additional yield over safer investment-grade corporate bonds. This spread is down from recent levels and indicates that investors are pursuing higher risk strategies.

Investors tend to feel the wrong feeling at the wrong time as they oscillate between the fear of missing out and the fear of losing money.

Another useful gauge I follow is the AAII Sentiment Survey. Since 1987, AAII members have been answering the same simple question each week. The results are compiled into the AAII Investor Sentiment Survey, which provides insight into the mood of individual investors. Today’s AAII Sentiment Survey shows Investors are optimistic again. Optimism is above 40% on back-to-back weeks for the first time since August 2018.

AAII Investor Sentiment Survey

The investor misbehavior of thinking, feeling, and doing the wrong thing at the wrong time doesn’t just include individual investors, but also many professional investment managers.

‘Fear of missing out’ triggers huge fund manager shift from cash to stocks,

The latest Bank of America Merrill Lynch investment fund managers survey shows fund manager cash levels are lowest in six years  and

“Investors are experiencing Fomo—the fear of missing out—which has prompted a wave of optimism and jump in exposure to equities and cyclicals,”

According to ‘Fear of missing out’ triggers huge fund manager shift from cash to stocks, Bank of America Merrill Lynch says:

The survey of 230 managers running $700 billion of assets found cash levels dropped 0.8 percentage points to 4.2%, the biggest monthly drop since Nov. 2016 and the lowest cash balance since June 2013.

Like individual investors, many investment managers also oscillate between the fear of missing out and the fear of losing money. This may be especially true for relative return mutual fund type active managers who aim to beat an index benchmark. If they are underperforming their index after an uptrend, they may feel the fear of missing out and increase their exposure. If they lose as much or more on the downside, they may tap out after the fact to avoid further losses.

An objective of absolute returns necessarily requires seeing, believing, and doing things differently as an independent thinker.

As investors seem to be taking on more risk, I see indications that stocks may be near a point of buying exhaustion. Keep in mind, these investor sentiment surveys are on a lag. It was probably this very optimism that pushed stocks to this higher level.

If there is enough enthusiasm left to keep driving prices higher, the uptrend will continue as long as optimism prevails. If instead these indicators and surveys are a signal of buying exhaustion, we’ll see prices fall at some point from here.

I focus on these extremes in investor sentiment.

So, it may be a good time to reduce or hedge off some risk.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The use of this website is subject to its terms and conditions.

Feeling and Doing the Right Thing at the Right Time

Last week I shared the observation that VIX Implied Volatility is Settling Down. The VIX Index is a  measure of the market’s expectation of future volatility, so the market is pricing in less volatility from here.

However, looking over the past five years, we can apply the 200-day simple moving average to the VIX to see vol oscillate between low vol regimes and a volatility expansion. Currently, it’s still somewhat a volatility expansion in comparison to recent periods, though the 17.80 level is below the long term average of 20. Everything is relative and evolving, so it depends on how we look at it.

vix volatility expansion regime change

Growing up on a small farm in East Tennessee I learned to “make hay while the sun shines.” Disasters happen if we try to make hay all the time or at the wrong time. I know many investors have a passive, all in, all the time approach, but I also saw farmers try to make hay in harsh weather. We have a better experience if we plan to make hay when the sun is shining rather than during a thunderstorm.

I believe the timing is everything.

Markets, especially stocks, are not normally distributed. We observe waterfall declines far beyond what is seen within a normal bell curve. These “tail risks” shock investors and cause panic selling. As panic selling drives prices lower, it results in more panic selling. Unfortunately, most investors natural inclination is to do the wrong thing at the wrong time. So, we see them getting too optimistic at peaks like January 2018 and then panic at lower prices like December 2018.

investor-emotion-market-cycles-fear-hope-greed1

If I am to have better results, I must necessarily be seeing, believing, and doing something very different than most people. In fact, what I’m doing should appear wrong to them when I’m doing it. So, to do the right thing overall, I must necessarily appear wrong to most when I’m doing it. That’s what I do, and I’m not afraid to do it. I just do what I do, over and over, and if someone doesn’t like it, they don’t have to ride in our boat.

I occasionally share a glimpse of the many indicators that generate signals that help to inform me. Most of these indicators I share aren’t actual trade signals to buy or sell, but instead, I use them for situational awareness. I don’t want to be one of the people in the above chart. I prefer to instead reverse it. If I’m going to experience any feelings, I want to feel greed when others are in a panic and feel fear when others are euphoric. That’s how I roll at the extremes. More often, we are in a period between those extremes when I just want to be along for the ride.

In several observations recently like An exhaustive analysis of the U.S. stock market on December 23rd, I covered the Put/Call Ratios and other indicators because they had spiked to extreme levels. In some cases, like the CBOE Total Put/Call Ratio spiked to 1.82 in late December, which is its highest put volume over call volume ratio ever.

A put-call ratio of 1 signals symmetry: the number of buyers of calls is the same as the number of buyers for puts. However, since most individual stock investors buy calls rather than puts the ratio of 1 is not an accurate level to gauge investor sentiment. The long term average put-call ratio of 0.7 for the Equity Put/Call Ratio is the base level I apply. Currently, the Equity Put/Call Ratio is back down to 0.54, which indicates a bullish investor sentiment. A falling Put/Call ratio below its longer-term average suggests a bullish sentiment because options traders are buying a lot more calls than puts. In fact, it’s a little extreme on the bullish side now. I wouldn’t be surprised to see the stock market decline some and this level trend back up.

equity put call ratio asymmetric risk reward

The Index Put/Call Ratio is often greater than one because the S&P 500 index options are commonly used by professional investment managers to hedge market risk. At 0.99 I consider this to signal there isn’t a lot of hedging right now so I wouldn’t be surprised to see stocks pull back some and the ratio trend up more. It isn’t an extreme bullish sentiment, but maybe a little complacent.

cboe index put:call ratio aymmetric risk reward

So, in just about four weeks we’ve seen the sentiment of investors swing from one extreme back within a more normal range. I can’t say the current levels are extreme enough to be any significant signal, but they are drifting that way.  Investors currently see this is a “risk on” regime, so we’ll go with the flow until it changes. By these measures and others, we are seeing them approach a level to become more aware of an elevating potential for a counter-trend.

The good news is, none of this has to be perfect. Asymmetric risk-reward doesn’t require a 100% win ratio, it’s about the average gain exceeding the average loss. For me, it’s more about magnitude than probability.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The stock market trends up with momentum

When the stock market indexes swing up or down 1% or more I try to share my observations of the directional trend and changes in volatility. Continuing from my observation yesterday in Observations of the stock market decline and volatility expansion when I shared:

The good news is, we’ve now experienced some volatility expansion, stocks have now pivoted down to the lower end of their cycles, so maybe volatility will contract and stock prices resume their uptrend.

We’ll see.

Well, today we saw.

The U. S. stock market gains were broad across all sectors. Communication Services, Consumer Discretionary, Healthcare, and Technology were the relative momentum leaders.

stock market trend sector ETF momentum

Continuing with the % of S&P 500 stocks above their 50 day moving average as breadth indicator was another indication of broad upward momentum. 86% more stocks are trading above their shorter-term trend, an expansion from a low level. For those of us who like to enter trends early in their stage, this is a positive sign of improvement for the stock market.

percent of stocks above below 50 day moving average trend following momentum

We observe the same in the percent of stocks trending back above their longer-term trends. There was a 16% expansion in the stocks in the S&P 500 index trending above their 200 day moving average. The longer-term trend indicators are slower to respond, but this is more evidence of positive directional movement.

stock momentum percent of stocks above 200 day moving average trend following asymmetric

This is happening at a time when many investor sentiment indicators suggest fear has been driving stocks recently. A simple example is the Fear & Greed Index, which reached “Extreme Fear” a week ago.

CNN FEAR GREED INDEX SENTIMENT

As a portfolio manager for the past two decades, I have observed investor sentiment oscillate between fear and greed, but as a contrarian pendulum. Most investors feel the wrong feeling at the wrong time.

  • After prices rise, investors get more optimistic as they extrapolate the recent gains into the future expecting the gains to continue.
  • After prices fall, investors fear losing more money as they extrapolate the recent losses into the future expecting them to get worse.

What happens, though, is market trends move in multiple time frames of cycles up and down. Prices can overreact to the upside and downside and the majority of investors seem to get it wrong.

The level and direction of implied volatility is an indication of investor sentiment. I’ve shared my observations of the volatility expansion and noted some volatility contraction yesterday. So far, the volatility expansion has reversed to contraction, so the expected volatility as implied by options prices now suggests the market expects lower volatility in the weeks ahead.

VIX VOLATILITY CONTRACTION EXPANSION ASYMMETRIC RISK HEDGE ASYMMETRY

But, just as I pointed out on September 25th in VIX level shows market’s expectation of future volatility implied volatility can get it wrong. I pointed out then the implied volatility was very low signaling to me the market may have been wrong to expect such low future volatility, so it can reverse back up again.

In summary, today was a strong upward momentum day for the stock market and most stocks participated in the uptrend. After sharp declines like we’ve seen this month, the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low. After the test, we then find out if it breaks down or breaks out.

One day doesn’t make a trend, but for those who are in risk taker mode with stocks, so far, so good.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

What trends are driving emerging markets into a bear market?

In Emerging Markets Reached a Bear Market Level we noted the emerging markets index has declined -20%, which is considered to be in bear market territory. The emerging markets index includes 24 countries classified as emerging countries.

To see the country exposure, we examine the iShares MSCI Emerging Markets ETF holdings. China is about 31%, South Korea is about 15%, Taiwan is over 12%, so the top three countries make up 58% of the country exposure. Add India at 10% and the top four countries is a dominant 68% of the exposure. Clearly, we’d expect the drift of these top holdings to dominate the trend.

what countries are emering markets ETF ETFs

Below we see the 2018 price trends of the emerging markets ETF and the top four countries that make up 68% of the emerging markets index ETF exposure. We see that South Korea and China are the primary downtrends that are trending close to the emerging markets index ETF. Taiwan and India have stronger relative momentum.

emerging markets $EEM china $FXI india south korea 2018 trend

To get a better understanding of what is driving the downtrend, we draw the % off high charts to see the drawdowns. From this observation, we can see what is really driving the trend. Of the top four countries in the index, the negative momentum of China and South Korea are driving the trend down. China is down -24% over the past year as South Korea is down -17%.

emerging market ETF trends

Taiwan and India have stronger relative momentum since they have trended up more recently since July. Prior to July, they were trending closer to China and South Korea.

You can probably see why I include the individual countries in my global universe rather than just the broad emerging markets index ETF that includes 24 countries. I want to find potentially profitable price trends, so I increase my opportunity to find them when I give myself more options.

There are 24 countries represented in the MSCI Emerging Markets Index and we’ve looked at the top 4 because they are given 68% of the exposure. That leaves only 32% in the other 20 countries. So, in regard to understanding what is driving the MSCI Emerging Markets Index, viewing the trend of the top holdings is enough to get an idea of the countries driving returns. But, in wanting to go find potentially profitable price trends, I research all the countries trends.

What about the rest of the emerging markets countries? 

Looking at the other 20 countries classified as emerging markets, I’ll divide them into groups. First, we’ll look at the other countries that are down -10% or more year-to-date. Then, I’ll draw a chart of those that are down this year,  but not as much. We’ll end with the few that are positive in 2018.

Emerging markets countries down the most year-to-date include Turkey, South Africa, Indonesia, Brazil, Philippines, Chile, Poland, and Peru. Priced in U.S. dollars, these countries are down between -14% and -52%. Turkey is down the most.

emerging markets countries down 2018 $EEM

Looking at their % off high shows us the drawdown over the past year, which is a different perspective. If you had held one of these ETFs, this is the amount it would be down from its highest price over the past year.

Emerging markets countries down the most 2018

Clearly, these emerging countries are in downtrends and a bear market if we define a bear market as a -20% decline. Keep in mind, these ETFs are foreign stocks priced in U.S. dollars, so to U.S. investors, this is what the trends of these countries look like.

Next, we observe emerging markets countries that are down less than -10% in 2018. Russia, Columbia, Thailand, and Malasia are down between -3% and 8% so far. Their trends are generally down: lower highs and lower lows.

emering markets year to date 2018

We can see the downtrends in a different perspective when we view their drawdowns as a % off high over the past year.

emering market countries percent off high asymmetric risk reward

I saved the best for last. The strongest trending top momentum emerging markets countries so far in 2018 are Mexico, Taiwan, Saudi Arabia, and Qatar. Saudi Arabia was previously classified as a smaller frontier market, but, this summer MSCI announced it will include the MSCI Saudi Arabia Index in the MSCI Emerging Markets Index.

top momentum emerging markets countires 2018

Hearing names like Mexico, Taiwan, Saudi Arabia, and Qatar may highlight home country bias for some investors. Home country bias is the tendency for investors to favor companies from their own countries over those from other countries or regions.

I don’t have a home country bias. I am open to finding potentially profitable price trends in any country around the world. We encourage investors to be open to global trends and not limit their choices, but if our clients don’t want exposure to any specific country, we are able to exclude it in our ASYMMETRY® Managed Portfolios.

While the United States is the single largest economy in the world, according to JP Morgan it accounts for only a small fraction of global GDP and just over 35% of the world’s capital markets. Yet, studies show that U.S. investors have nearly 75% of their investments in U.S.-based assets. As we’ve shown here, there has been a good reason to avoid emerging countries for now, but as we explain in Emerging Markets Reached a Bear Market Level there are times when these countries present strong relative momentum over U.S. stocks.

This is why I tactically shift between global markets based on their directional price trends rather than a fixed buy and hold global asset allocation.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

 

 

 

 

 

The week in review shows some shifts

Much of the observations I shared last week are continuing to be more apparent this week.  So, in case you missed it, this may be a good time to read them.

Earnings season is tricky for momentum growth stocks

I discussed how earnings season can drive a volatility expansion in stocks, especially high growth momentum stocks. The stock market leaders can become priced for perfection, so we never know how investors will react to their earnings reports. To achieve asymmetric returns from momentum stocks, we need a higher magnitude of positive reactions than adverse reactions over time. On a quarterly basis, it can be tricky. The gains and losses as much as 20% or more in the most leading momentum stocks like Facebook ($FB), Google ($GOOGL), Twitter ($TWTR), Grub ($GRUB), and NetFlix ($NFLX) have since provided a few examples.

Front-running S&P 500 Resistance

In Front-running S&P 500 Resistance I shared an observation that many market technicians incorrectly say support and resistance appear before it actually does. We won’t know if resistance to a price breakout exists until the price actually does pause and reverse. I suggested the S&P 500 may indeed pause and reverse, but not because the index drives the 500 stocks in it, but instead because my momentum indicators suggested the $SPY was reaching a short-term overbought range “So, a pause or reversal, at least some, temporarily, would be reasonable.” As of today, the S&P 500 has paused and reversed a little. We’ll see if it turns down or reserves back up to continue an uptrend.

Asymmetry of Loss: Why Manage Risk?

asymmetry of loss losses asymmetric exponential

In Asymmetry of Loss: Why Manage Risk? I showed a simple table of how losses compound exponentially. When losses become greater than -20%, it becomes more exponential as the gains required to recover the loss are more and more asymmetric.  This simple concept is essential and a cornerstone to understanding portfolio risk management. Buy and hold type passive investors who hold a fixed allocation of stocks and bonds are always fully exposed to market risk. When the market falls and they lose -20%, -30%, -50% or more of their capital, they then face hoping (and needing) the market to go back up 25%, 43%, or 100% or more just to get back to where they were. This can take years of valuable time. Or, it could take a lifetime, or longer. Just because the markets have rebounded after being down for four or five years from their prior highs doesn’t guarantee they will next time. Past performance is no guarantee of future results.

Trend following applied to stocks

In Trend following applied to stocks, the message was short and sweet: gains are produced by being invested in stocks or markets that are trending up and losses are created by stocks trending against us. Investors prefer to be in rising stocks and out of falling stocks. But, as I showed in Earnings season is tricky for momentum growth stocks the trick is giving the big trends enough room to unfold. In fact, applying trend following and momentum methods to stocks is also tricky. It’s a skill that goes beyond just looking at a chart and it’s not just a quantitative model.

Stock market investor optimism rises above the historical average

About two weeks ago,  the measures of investor sentiment showed a lot of optimism about future stocks prices, so we shouldn’t have been surprised to see some stocks fall. When a lot of enthusiasm is already priced in, investors can respond with disappointment when their stocks don’t live up to high expectations.

Much of the momentum and trend following in stocks is driven by an overreaction to the upside that can be accompanied by an overreaction to the downside. A robust portfolio management system factors these things in.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Stock market investor optimism rises above historical average

“Optimism among individual investors about the short-term direction of the stock market rebounded, rising above its historical average.”

AAII Investor Sentiment Survey

The AAII Investor Sentiment Survey is a widely followed measure of the mood of individual investors. The weekly survey results are published in financial publications including Barron’s and Bloomberg and are widely followed by market strategists, investment newsletter writers, and other financial professionals.

It is my observation that investor sentiment is trend following.

Investor sentiment reaches an extreme after a price trend has made a big move.  After the stock market reaches a new high, the media is talking about and writing about the new high, which helps to drive up optimism for higher highs.

When they get high, they believe they are going higher.

At the highest high they are at their high point — euphoria.

No, I’m not talking about cannabis stocks, I’m just talking about the stock market. Cannabis stocks are a whole different kind of high and sentiment.

A few years ago, I would have never dreamed of making a joke of cannabis stocks or writing the word marijuana on a public website. Who had ever thought there would be such a thing? But here I am, laughing out loud (without any help from cannabis).

Back to investor sentiment…

Excessive investor sentiment is trend following – it just follows the price trend.

Investor sentiment can also be a useful contrarian indicator to signal a trend is near its end. As such, it can be helpful to investors who tend to experience emotions after big price moves up or down.

  • Investor sentiment can be a reminder to check yourself before you wreck yourself.
  • Investor sentiment can be a reminder to a portfolio manager like myself to be sure our risk levels are where we want them to be.

Although… rising investor optimism in its early stages can be a driver of future price gains.

Falling optimism and rising pessimism can drive prices down.

So, I believe investor sentiment is both a driver of price trends, but their measures like investor sentiment polls are trend following.

For example, below I charted the S&P 500 stock index along with bullish investor sentiment. We can see the recent spike up to 43% optimistic investors naturally followed the recent rise in the stock price trend. investor sentiment July 2018

However, in January we observed something interesting. Investor sentiment increased sharply above its historical average in December and peaked as the stock market continued to trend up.

Afterward, the stock market dropped sharply and quickly, down around -12% very fast.

Maybe the investor sentiment survey indicated those who wanted to buy stocks had already bought, so there wasn’t a lot of capital left for new buying demand to keep the price momentum going.

The S&P 500 is still about -2.4% from it’s January high, so this has been a non-trending range-bound stock market trend for index investors in 2018. The Dow Jones Industrial Average was last years more gaining index and it is still -6% from its high.

stock market 2018 level and drawdown

The stock index will need some buying enthusiasm to reach its prior high.  We’ll see if the recent increase in optimism above its historical average is enough to drive stocks to new highs, or if it’s a signal of exhaustion.

Only time will tell…

I determine my asymmetric risk/reward by focusing on the individual risk/reward in each of my positions and exposure across the portolio. For me, it’s always been about the individual positions and what they are doing.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

 

The week in review

The week in review

In case you missed it, below are all of the observations we shared this week. When there are more directional trend changes and volatility, I find more asymmetries to write about. That’s because I look at markets through the lens of “what has changed”?

When I observe more divergence between markets and trends, I see more asymmetries to share.

When global markets are just trending up together and quiet, investor sentiment is usually getting complacent, I typically point it out, since that often precedes a changing trend.

All of it is asymmetric observations; directional trends and changes I see with a tilt.

The opposite is symmetry, which is a balance. Symmetry doesn’t interest me enough to mention it.

When buying interest and selling pressure are the same, the price doesn’t move.

When risk equals the return, there is no gain.

When profit equals loss, there is no progress.

In all I do, I’m looking for Asymmetry®.

I want my return to exceed the risk I take to achieve it.

I want my profits to far surpass my losses.

I want my wins to be much greater than my losses.

I want more profit, less loss.

You probably get my drift.

 

Here are the observations we shared this week: 

Growth has Stronger Momentum than Value

https://asymmetryobservations.com/2018/06/25/growth-has-stronger-momentum-than-value/

 

Sector Trends are Driving Equity Returns

https://asymmetryobservations.com/2018/06/25/sector-trends-are-driving-equity-returns/

 

Trend Analysis of the Stock Market

https://asymmetryobservations.com/2018/06/25/trend-analysis-of-the-stock-market/

 

Trend of the International Stock Market

https://asymmetryobservations.com/2018/06/26/trend-of-the-international-stock-market/

 

Interest Rate Trend and Rate Sensitive Sector Stocks

https://asymmetryobservations.com/2018/06/27/interest-rate-trend-and-rate-sensitive-sector-stocks/

 

Expected Volatility Stays Elevated in 2018

https://asymmetryobservations.com/2018/06/27/expected-volatility-stays-elevated-in-2018/

 

Sector ETF Changes: Indexes aren’t so passive

https://asymmetryobservations.com/2018/06/27/sector-etf-changes-indexes-arent-so-passive/

 

Commodities are trending with better momentum than stocks

https://asymmetryobservations.com/2018/06/28/commodities-are-trending-with-better-momentum-than-stocks/

 

Investor sentiment gets more bearish

https://asymmetryobservations.com/2018/06/28/investor-sentiment-gets-more-bearish/

 

Is it a stock pickers market?

https://asymmetryobservations.com/2018/06/29/is-it-a-stock-pickers-market/

 

Investor sentiment gets more bearish

Investor sentiment gets more bearish

Investor pessimism shifted to an unusually high level for the time this year. It spiked up from 24% bearish to 41%.

investor sentiment investment strategy

Bearish investor sentiment is now as high as it was in April after the stock declined a second time and formed a double bottom. Interestingly, this time the stock market is only down about 6% from its high. The last time investors were so bearish it had reached -10%, for the second time.

bearish investor sentiment

Investors may be turning more bearish more quickly since the stock market remains in a drawdown. Investors tend to feel the wrong thing at the wrong time at extremes so this could be a bullish signal.

Investor optimism declined more moderately and still remains within its normal long-term range. We can see how optimism trend up to an extreme in January as the stock index reached an all-time new high and investors were becoming euphoric.

bullish investor sentiment signal

Investor sentiment measures show that investors do the wrong thing at the wrong time as their beliefs about future stock market returns reach the more extreme levels.

A good investment program isn’t enough to help clients reach their objectives.

We necessarily have to help them avoid the typical misbehavior the majority of investors fall in to.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Growth Stocks have Stronger Momentum than Value in 2018

Growth Stocks have Stronger Momentum than Value in 2018

After a sharp decline in stock prices in February that seemed to shock many investors who had become complacent, the stock market indexes have been trying to recover.

At this point, the popular S&P 500 has gained 1.75% year-to-date and the Dow Jones Industrial Average is down -2.56%. I also included the Total Stock Market ETF, which tracks an index that represents approximately 98% of the investable US equity market. Though it holds over five times more stocks than the 500 in the S&P 500 SPY, it is tracking it closely.

stock market index returns 2018 SPY DIA

The Dow Jones Industrial Average was the momentum leader last year, but the recent price action has driven it to converge with the other stock indexes. Past performance doesn’t always persist into the future.

Dow was momentum leader

What is more interesting, however, is the divergence at the size, style, and sector level.

The research firm Morningstar created the equity “Style Box.” The Morningstar Style Box is a nine-square grid that provides a graphical representation of the “investment style” of stocks and mutual funds. For stocks and stock funds, it classifies securities according to market capitalization (the vertical axis) and growth and value factors (the horizontal axis).

equity style box

  • The vertical axis of the style box graphs market capitalization and is divided into three company-size indicators: large, medium and small.
  • The horizontal axis seeks to represent stock funds/indexes by value, growth, and blend which represents a combination of both value and growth.

Looking at their distinct trends, we observe a material divergence this year. As we see below, the S&P 500 Growth Index ETF has gained 16.45% % over the past 12 months, which is triple the S&P 500 Value ETF. So, Growth is clearly exhibiting stronger momentum than value over the past year. But, notice that wasn’t the case before the February decline when Growth, Value, and Blend were all tracking close to each other.

 

Equity Style and Size Past 12 Months

Year to date, the divergence is more clear. Growth is positive, the blended S&P 500 stock index is flat, and Value is negative.

momentum growth stocks 2018

Showing only the price trend change over the period isn’t complete without observing the path it took to get there, so I’ve included the drawdown chart below. Here, we see these indexes declined about -10% to as much as -12% for the Value index.

The Value index declined the most, which requires more of a gain to make up for the decline. The Value ETF hasn’t recovered as well as the others.

To look even closer, we can get more specific into the style and size categories. Below we show the individual Morningstar ETFs that separate the stock market into the Large, Mid, and Small size stocks and then into Growth vs. Value.

All three at the top are Growth. The three at the bottom are Value. So, the divergence this year isn’t so much Large vs. Small cap, it’s Growth vs. Value.

Clearly, Growth stocks are leading the stock market so far in 2018.

Why do we care about such divergence?

When there exists more difference between price trends, it provides more opportunity to capture the positive direction and avoid the negative trend if it continues.

In part 2, we’ll discuss how sector exposure is the primary driver of style/size returns.

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

You want to be fearful when others are greedy?

“You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple.… ” – Warren Buffett

Investors are emotional and we can profit from it.

Though investors are emotional, they can also manage their emotions to feel the right feeling at the right time.

Market trends are both the result of investor behavior and driven by it. Anyone who watches “the market” has had feelings of fear and greed at some point. Those who “watch it closely” feel it often.

  • Fear: I am losing money! Is it ever going to stop?
  • Worried: How much more money will I lose?
  • Defeated: I’ve lost so much money I don’t know what I’m going to do.
  • Hope: I hope I make money this time. I hope it keeps going up!
  • Greed: I’m up X%! Up! this, Up! that. I’m up!
  • Euphoric: I’m going to tell everyone how much I’m UP! Up, up, and away!

All of these feelings and reactions drive directional price trends. Emotions also determine investor’s results. Investor behavior determines investor’s results as much as their investment program or the market.

fear-and-greed-index-explaination-cnn

Investor sentiment just reached “Extreme Greed” again. Investor sentiment tends to swing from “Fear” to “Greed” a few times a year, mostly reacting to the price trend. That is, we don’t see the majority of investors getting fearful when others are greedy. Instead, we see them get fearful after prices have fallen and they’ve lost some value. We don’t see investors getting greedy after prices fall, we instead see them get greedy after prices have already gained and they are “up”.

Being “up” in a position doesn’t mean anything if it’s “down” in the next period.

Being “up” in a position is an open profit until it’s closed.

An open profit is just the markets money until it’s realized by selling it.

A realized gain is a profit that has been taken by selling.

The Fear & Greed Index I used above is one that is simple to follow for anyone who wants to give themselves a reality check.

If you find yourself feeling euphoric and talking about how great “the market” or your investments are “doing”, this measure is likely dialed to the right for “Extreme Greed”.

If you find yourself fearful of more losses after losses you may be taking too much risk, but it could also be near a turning point. One the one hand, you don’t want to reach your uncle point and tap-out. So, you predefine your tolerance for loss and match that with an investment program that includes risk management and drawdown control.

You want to avoid doing the wrong things at the wrong time- as the quote said.

Although the Fear & Greed Index equally weights seven different sentiment indicators, the most prominent of them is the CBOE Volatility Index® (VIX® Index®), which is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. When the VIX gets really low like it is now, it suggests that expectations for near-term volatility is very low.  I say “really low” because, as you can see, its current level of 10.74 is about as low as it’s gotten since introduction in 1993. That’s a contrary indicator because it’s at such an extreme. It seems the market is getting complacent and any surprise will shock them.

vix-cboe-volatility-index

What does this mean?

We shouldn’t be surprised to see the recent upward price trend reverse down some, at least temporarily.

And, those who apply the simple-sounding strategy of “You want to be greedy when others are fearful. You want to be fearful when others are greedy.” may start to take some profits and preparing to take advantage of, or avoid, a later decline.

It doesn’t mean it will be a large decline, though it could be. For example, the last time I pointed out “Investor Optimism is Reaching Extreme” was December 9th of last year. As you can see below, the stock index dropped only about -2% over the next two weeks. That’s a small drop. Based on history, we expect to see swings of stock index prices of -5% to -10% two or three times a year. When I see such overbought conditions as I see now, I expect that level of normal decline.

decline-since-fear-and-greed-index

The upward trend in U.S. stocks has mostly been uninterrupted since last November. You can probably see how this just adds to the weight of the evidence that we shouldn’t be surprised to see a “normal” drop at some point. As a tactical trader, I prefer to avoid large declines when I can and take advantage of them.

We’ll see how it unfolds this time…

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

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