“Purpose is a more powerful motivator than money. When you are not paid as much as you would like, your purpose will provide you a reason to continue producing excellence in your work. When you have more money than you ever thought possible, your purpose will provide you with a reason to continue producing excellence in your work.” – William J. O’Neil
Did you know the Woodstock Music Festival in 1969 took place during a global pandemic?
It killed about 100,000 people in the U.S. and a million worldwide.
According to Jeffrey A. Tucker, the Editorial Director for the American Institute for Economic Research:
“The flu spread from Hong Kong to the United States, arriving December 1968 and peaking a year later. It ultimately killed 100,000 people in the U.S., mostly over the age of 65, and one million worldwide.”
And yeah, it was fact checked by Reuters:
“It is true that Woodstock occurred during the Hong Kong flu pandemic, which was a global outbreak.”
In “True claim: Woodstock took place in the middle of a pandemic,” Reuters Fact Check makes the verdict:
“True. The 1969 Woodstock music festival did take place during a global pandemic, the Hong Kong flu, which started the previous year.”
The U.S. Centers for Disease Control and Prevention (CDC) explains on its website:
“It was first noted in the United States in September 1968. The estimated number of deaths was 1 million worldwide and about 100,000 in the United States. Most excess deaths were in people 65 years and older. The H3N2 virus continues to circulate worldwide as a seasonal influenza A virus.”
Woman running through the mud at the Woodstock Music Festival, New York, US, 17th August 1969. (Photo by Owen Franken/Corbis via Getty Images))
So, there you go.
It’s not so different this time, except in ’69 they still carried on with concerts like Woodstock and such.
According to Tucker;
“Nothing was closed by force. Schools mostly stayed open. Businesses did too. You could go to the movies. You could go to bars and restaurants.”
I’ve not had a problem with the Stay at Home orders, and it hasn’t changed my life much, other than we miss hanging out with friends and going out to dinner.
But, he also says;
“Stock markets didn’t crash. Congress passed no legislation. The Federal Reserve did nothing. Not a single governor acted to enforce social distancing, curve flattening (even though hundreds of thousands of people were hospitalized), or banning of crowds. No mothers were arrested for taking their kids to other homes. No surfers were arrested. No daycares were shut even though there were more infant deaths with this virus than the one we are experiencing now. There were no suicides, no unemployment, no drug overdoses.”
So, yeah, maybe the modern day connectivity has amplified the outcome and caused some initial under-reaction and then overreaction?
I’m not surprised.
It’s just the people, doing what they do.
Read the whole story, it’s been fact checked and found to be accurate: Woodstock Occurred in the Middle of a Pandemic.
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.
We tend to find information that confirms our existing beliefs.
We’re seeing it more than ever, if we pay attention and recognize it.
If you feel we should stay on lock down and maintain the quarantine, you find news and opinions that support yours.
If you feel it’s all just a hoax and the quarantine has been a disaster, you find news and opinions that support yours.
If you feel the lock down has been necessary, but now the curve has flattened, so it’s time to open the United States for business, you find news and opinions that support yours.
Yes, I said “we”, because I do it, too, but the difference may be; I know it do, so I’m aware of it.
Awareness allows us to recognize it, then we get to decide if we want to do it, or not.
In other words, we decide if we want it, or not.
Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms or strengthens one’s prior personal beliefs or hypotheses. It is a type of cognitive bias.
One says about cognitive bias:
A cognitive bias is a systematic error in thinking that affects the decisions and judgments that people make. Some of these biases are related to memory. The way you remember an event may be biased for a number of reasons and that in turn can lead to biased thinking and decision-making.
Another defines it as:
A cognitive bias is a systematic pattern of deviation from norm or rationality in judgment. Individuals create their own “subjective reality” from their perception of the input. An individual’s construction of reality, not the objective input, may dictate their behavior in the world.
I like the “subjective reality” part.
We aren’t objective, unless we want to be.
Wikipedia says;
Objectivity is a philosophical concept of being true independently from individual subjectivity caused by perception, emotions, or imagination. A proposition is considered to have objective truth when its truth conditions are met without bias caused by a sentient subject.
Simply put, objectivity is when our judgment isn’t influenced by personal feelings or opinions in considering and representing facts.
Yeah, tell me how often you are objective about things, leaving out your feelings and opinions, or considering the facts as you see them.
So, to be objective is not being influenced by personal feelings, interpretations, or prejudice; based on facts; and unbiased.
An objective opinion is an intention of dealing with things without taking into considering our own beliefs, thoughts, opinions, and feelings.
Who does that?
I think we’re going to feel our feelings, experience them, one way or another.
I also think it’s hard to ignore our own judgement and perceptions.
And then there’s feelings. If the topic drives our emotions, it makes us scared, mad, or happy, then it’s hard to get past it, unless we really want to.
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We sometimes get lazy, and we just don’t want to pay attention anymore, so we just take those mental shortcuts. The easy way it is so, easy.
When it comes to the lockdown, Physicians who are concerned about their hospitals being overwhelmed may prefer it this way, so they’ll find information that supports their own individual motivations.
Other Physicians may earn their living doing surgeries that aren’t labeled a necessity, so their motivation is to get back to work. They may be more biased toward finding information that supports opening for business.
What is wrong with having your own opinion or personal motivations?
Nothing.
It’s useful to pay attention and know we have it.
It’s an example of how we find ways to get what we want.
We decide what we get.
Our cognitive biases influence how we think and act, so it’s useful to be aware of what it is we want, because we’re going to find information that supports what we want.
Sometimes we just don’t have time to think for ourselves, so we just find information from trusted people and go with it. My observations here is an example, especially when it comes to market trends and such.
We have to be selective in how we pay attention to what’s going on the world around us because we simply don’t have time to observe it all. I realized this two decades ago, so I developed systems for monitoring what has changed, systematically. I don’t have to sit around and look for it manually, I get alerts. When something has changed enough to send me a signal, then I look to see if I believe it matters.
Should you listen to others?
Only if they’re better at it than you are, and have more focus. Concentration is key, to me. My track record speaks for itself, especially during bear markets and volatility expansions. I’ve now operated through three major bear markets and a hundred volatility expansion. This isn’t new for me.
More importantly, I didn’t just “hunker down” and buy and hold through market crashes like 2000-03 or 2007-09. I tactically traded through them, successfully, and managed my drawdowns within a tolerable level. Past performance is never a guarantee of future results, but I’d rather drive my own boat through this storm than ride with anyone else. I’ve learned many lessons that should add to my skill and experience, so I’m likely to get what I want, but likely isn’t a sure thing.
What we believe about the virus and the lockdown depends on our personal beliefs, and we probably find things that support what we already believe. Nothing I write is guaranteed change your mind. You’ll instead compare it to the observations and opinions of others, but most importantly, you own.
That is, unless you intentionally look at the data with determination to be objective.
I know, it’s hard. Who does that?
A simple equation: Intentions = results.
In Market Wizards: Interviews with Top Traders, Ed Seykota, one of the famous traders interviewed, said:
“Win or lose, everyone gets what they want from the market.”
It means our intentions equals our results. Our intentions create our results.
For example, you have an opinion about the stock market right now. You have a feeling about it. You have beliefs. You may draw from the beliefs and opinions of others. You’re certainly focused on finding what confirms what you already believe, if you recognize it.
If you believe the stock market can’t possibly trend higher, you look for confirming information and opinions. If the market trends down and you avoided the loss, you got what you wanted. If the market trends up and you missed out, you got what you wanted. You wanted to avoid the downtrend you believe should happen. It doesn’t matter if it does, or not.
If you believe the stock market will go to the moon again because the Fed is intent on it, you’ll expose your portfolio to your belief. If the market trends up and you participate in its profits, you got what you wanted. If the market instead trends up and you participate in its losses, you got what you wanted. You believed it should trend up and you wanted exposure to what you believe should happen. It doesn’t matter if it does, or not.
What you believe is true, for you.
It’s how we get what we want.
We decide what we get. So, if we want to be empowered, create our own outcomes, we must necessarily take responsibility for them. When we take responsibility for our outcomes, we get the results we want.
Knowing what I know, having operate through times like this before, you’re going to need it. That is, unless you choose to be a victim. But I just made you aware that’s a choice, too.
I want to use my skills and experience to make the best of what is going to happen next.
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.
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.
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.
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 Tactical. Mike 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.
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.
What we have witnessed in the global equity markets is a waterfall decline, the question now is if the plunge pool has developed.
An 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.
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…
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.
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.)
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.
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?
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.
To no surprise, the Fear & Greed Index was penned all the way back to 1 after yesterday’s close.
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.
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 Tactical. Mike 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.
At the moment, the popular US stock market indexes are down over 25% from their years year-to-date.
Looking at the Cycle of Market Emotions, where do you think we are at this moment?
The magnitude and speed of the decline are impressive by any measure. For example, below I charted two different historical (realized) volatility measures around the stock index. The green area is a channel of average true range, which I used to define the normal noise of the market. The waterfall decline has been anything but normal, as it has exceeded two times its average true range several times. We can say the same for the standard deviation, which is the red line.
This price action is a “black swan” outside anything ‘normal’, so this is an extreme level of panic selling.
Looking at the Cycle of Market Emotions, this is the panic phase
Based on price action across global markets including many alternative assets like Real Estate, Energy MLPs, and investor sentiment measures, this is the panic, capitulation, and despondency phase. The reality of a bear market has to the fore and investors are panicking. Many panic and tap-out from the market from of fear of further losses. Those who stay in and endure the decline may become despondent and wonder whether the markets are ever going to recover. They’ll start to think “this time is different” and we’ve never seen anything like this before.
We haven’t, and this time is necessarily different, as it’s a new moment that never before existed. All market trends are unique because all new momentums are unique – never existed before. But, that doesn’t mean we can use the past to understand future possibilities. History is all we have as a guide and our past experience is essential at times like this. As my focus is on investor behavior and how it drives market trends, momentum, and volatility, I’ll be sharing my beliefs on this in the days ahead.
Ironically, it’s times like this investors fail to realize markets also reach the point of maximum asymmetric risk/reward after such a radical waterfall decline. We never know in advance if it will keep trending down or reverse. This downtrend has been a fine example as it wasn’t interrupted my much of a countertrend back up. But in the big picture, the more extreme a price move, the higher the likelihood of a swing the other way – at least short term. I said the same about the uptrend. I like uptrends, but sometimes when it comes to momentum; the higher they go, the lower they fall. That’s what we’re seeing now. Investors should also be prepared for the opposite; the speed and magnitude of this decline may result in correspondingly strong countertrend reversals.
This is panic level selling.
This is a volatility expansion, so expect prices to swing up and down.
This price trend will reverse when the selling pressure has exhausted and has driven prices down to a low enough point to attract the enthusiasm to buy.
Surely the trend is nearing that level at least on a short term basis. Market trends are a process, not an event, but this one has been a much faster and deeper process – and it feels like an event.
At times like this, it’s essential to be stoic. For me, as a professional investment manager who has tactically operated through many times like this before, a stoic is being calm, emotionally intelligent, focus on the things I can control and let go of those I can’t and most of all self-discipline.
Self-discipline is the ability to control one’s feelings and overcome one’s weaknesses; the ability to pursue what one thinks is right despite temptations to abandon it.
I started increasing exposure to stocks after they fell because my managed portfolio was in a position of strength. I was in US Treasuries at the January stock market high, so we missed the first big leg down. We’re participating now as I increased exposure the last two weeks, so my tactical decisions are never perfect and never a sure thing. I don’t have to get it perfectly right every time, which is impossible. I just keep doing what I do, over and over, with great self-discipline and the calm of a stoic.
Hang in there friends, this too shall pass.
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. 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.
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:
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.
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 Tactical. Mike 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.
The stock index falls below its long-term trend, but just as stocks are getting oversold. The 200-day moving average was about 11% below the high February 19th, just eight days ago.
As you can see in the chart, this has been a sharp waterfall decline and one I’m glad we avoided so far. For those of us in a position of strength, we stalk the market actively looking for a lower-risk entry point that offers the potential for asymmetric risk-reward payoff. An asymmetric payoff is when we structure our positions so our potential for downside loss is limited to much less than the potential for capital gains.
The stock market is now getting more oversold on a short term basis.
Only 21% of S&P 500 stocks are above their 50 day moving average. That’s a lot of broken uptrend lines shifting into downtrends.
In the chart, I colored the “buy zone” in green. As you can see, it’s now down to a level I consider an indication that selling pressure may become exhausted as long as prices have been sold down to a low enough level to attract buying demand.
The stock market, and stock prices, are driven by supply and demand. It’s that simple. Measuring supply and demand isn’t so simple for most investors.
In the bigger picture, the longer-term trend lines are still at the 50-yard line, which is where all but one of the past five declines stopped. Of course, the one time stocks really got sold down was late 2018. Only time will tell if this becomes another period like that, but right now, those of us who had reduced or removed exposure to the market losses are probably looking to buy.
The longer-term trend lines are holding better, which is no surprise because stocks had trended up well above their longer trend lines. For example, the S&P 500 index was trading about 11% above its own 200 day moving average and it just now crossed below it. When many stocks are trending that far above their trend line, it takes more of a price decline to trigger the percent of stocks to fall.
Stocks market declines to tend to be asymmetric. Prices trend down faster than they trend up. After prices trend down, contagion sets in the lower prices fall. Prices then get driven down even more simply because investors are selling to avoid further loss. But, someone has to be on the other side of their panic selling. It’s those who had the cash to buy.
If you sell higher, you can buy lower.
Need help? Contact us 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 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. 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.
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.
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.
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.
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.
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.
Meanwhile, the Fear & Greed Index, driven by 7 market sentiment indicators, is Neutral.
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.
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?”
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 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 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.
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.
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.
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.
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.
What about the savings rate?
This is one of my favorite non-market global macro trend charts. Total savings is trending up.
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.
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.
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.
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.
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 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 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.
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 S&P 500 gained over 3% the past 5 days anyway…
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.
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.
The headlines today:
“January adds a much stronger-than-expected 225,000 jobs, with a boost from warm weather” – CNBC
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 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 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.
We’ve seen a notable shift in investor sentiment.
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.
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.
The bull-bear spread chart has reversed down below its average level of the past year.
The Fear & Greed Index made up of seven different sentiment indicators is neutral now, down from Extreme Greed a month ago.
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.
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.
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 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 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.
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.
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. 
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.
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.
Who remembers how that turned out?
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%. 
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.
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.
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.
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.
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.
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.
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.
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.
AAII guesses:
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.
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:
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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? 
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.
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.
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.
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.
It may seem odd to hear a U.S. Marines Veteran who never played football under Phil Fulmer say he learned something about the Marine Corps motto “Semper Fi” from the old Tennessee coach.
Afterall, Semper Fi means “always faithful” but it also means “always loyal“.
I have learned a valuable lesson from this past decade from the firing of Phillip Fulmer as any Tennessee Volunteers fan probably has.
Before I go on, I’ll also be the first to say I am fully aware the following is an example of outcome bias: the tendency to judge a decision based on the outcome, rather than the quality of the decision at the time it was made. Outcome bias is a significant error observed often in investment management, but it applies to all human endeavors.
Back in 2008, Dusty Floyd explained it well:
150 career wins, a winning percentage of almost 75 percent, a national title, and five trips to the SEC championship in 17 years. How would a coach with this kind of résumé get fired?
Tennessee football coach Phillip Fulmer has done a great job at the University of Tennessee but has struggled in the past few years. In the past four seasons, Tennessee’s record has been 27-20. That’s way below par for a school with as much tradition as Tennessee has.
I have to admit, I too was excited when the University of Tennessee announced the hiring of Lane Kiffin. At the time, it seemed the fresh eyes and energy of a younger coach with a chip on his shoulder and something to prove was an exciting new direction for the Vols. I was especially excited to hear Lane Kiffin’s father, the famous Monte Kiffin of Tampa Bay Bucs, was going to join him along with an excellent recruiter Ed Orgeron. It seemed Tennessee had the potential to become an NFL looking powerhouse. And, it did.
At the same time, we were renovating Neyland Stadium and I was grateful to be able to invest in the prestigious new West Club. The donation was large enough to get a plaque on the front of Neyland Stadium behind the General Neyland statue, who was the only coach to win more games than Fulmer as a UT football coach.
On the wall behind the statue are the names of the proud donors, myself included.
We enjoyed the games at the West Club and most of the time stayed on our boat with the Vol Navy for the long weekend.
After a period of walking the walk of shame, losing to teams Tennessee should beat, we eventually bought a second home in Tampa, Florida and spent the winter and football season there. Now, we spend most of our time there and this summer was our first summer in Florida.
I’m not going to rehash what happened next and the roller coaster of the past decade. It’s a national story at this point. One of the most storied football programs in the county has had some highs, but many lows. Fortunately, with a few well-timed picks, we’ve got to be present for the highs such as the huge win over Virginia Tech at The Battle of Bristol, which holds the record for NCAA football’s largest single-game attendance at an astonishing 156,990. It was held at the Bristol Motor Speedway and we enjoyed it very much.
A football coach is measured by quarters, games, and seasons. If he doesn’t have the assistant coaches and players he wants, he has to make due and wait until next season. So, it could take a few years to get the adjustments right.
Phil Fulmer had lost David Cutcliffe, the outstanding UT offensive coordinator, who became the head coach of Duke, where he still is today. When Cutcliffe left, the offense struggled, and UT had it’s second losing season since 2005. So, one of the winningest coaches in college football history agreed to resign in a very emotional press conference.
I didn’t like the way that press conference felt, seeing the extremely passionate Phil Fulmer emotional on a national podium. It felt like betrayal and disloyalty then. It felt like a very proud football program had cut out one of its own, who played football at UT, in favor of a younger more aggressive coach with something to prove. At the time, Fulmer seemed to be still enjoying the fame of the 1998 National Championship and many SEC East wins.
Then came the young Lane Kiffin. We had hope of his fresh energy, but we know how that turned out. His true dream job opened up the very next season, and he bolted for the University of Southern California. Who could blame him? He had coached at USC and wouldn’t have to compete in the powerhouse Southeastern Conference and the likes of Nick Saban’s Alabama, Auburn, Georgia, Florida, LSU, and the list goes on.
Nevertheless, it was a harsh lesson of loyalty. Kiffin wasn’t loyal, but Fulmer was.
We’ve since had to endure the roller coaster of Dooley, Butch Jones, and now the new Jeremy Pruitt. Pruitt certainly has a better history than the former, so we’ve got to give him a chance to get it right. It isn’t going to happen overnight. He may have a rocky start on Rocky Top, but at this point, we’ve got to apply some semper fi. We now have Fulmer back at UT as the Athletic Director and he picked Pruitt, so let’s give him what he needs to succeed.
I’m going to the Tennessee vs. Georgia game today. We won’t be in our old West Club seats, but we’ll be front and center. Sure, we know the probable outcome in advance, but we’re here in Knoxville to cheer them on, win or lose.
The same applies to investment management.
If I applied the same mindset to any of my most profitable trading systems over the past two decades, we would have missed out and never achieved their long term asymmetric risk/reward profile. I operate about three dozen unique systems and not a single one of them wins all the time or always achieves our desired outcome. I have scientifically backtested thousands of systems of entry, exit, and position sizing, and risk management and even with perfect hindsight, we are unable to create perfect systems that perform well over every single market regime and condition. Even when I add my own skill, intuition, and experience I am unable to make it perfect.
What I’ve learned as an investment manager all these years is we have to make it okay to lose, or we would never cut our losses short and prevent them from growing into large losses. We have to be willing to experience imperfect periods of performance because we simply can’t achieve the asymmetric risk/reward profile we want to create without accepting the periods it doesn’t look as we want.
Today, I”m reminded of what I’ve learned about semper fi from Phillip Fulmer as I’m going to attend my first Tennessee football game since he became the UT AD.
There are many similar parallels between investment management and football coaching. There is a time for offense and a time for defense. Both require tremendous commitment, discipline, and execution to operate successfully long term. Some are much better at it than others and there is a significant divergence between the skill of the best and the mediocre.
What did I learn from Phil Fulmer?
Semper Fidelis: Always be faithful and loyal.
Stick to the system and stick with good people with passion.
In hindsight and a large dose of outcome bias, I’m pretty sure Phil Fulmer would have achieved more the past decade.
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 is 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. Use of this website is subject to its terms and conditions.
I like to observe the return drivers of price trends. Though I primarily focus on the direction of the price trend and volatility, I also consider what drives the price trend.
Yesterday I suggested the stock market was at a point of pause and possible reversal back up in The stock market is holding its breadth… for now. I shared some examples of how the percent of stocks in a positive trend had declined to a point that could indicate the selling in the near term could be drying up.
So far, today’s sharp reversal up seems to confirm at least a short term low.
Up until today, the S&P 500 stock index was down about -6% off its high. In May it dropped -8% before reversing back up to a new high. I express these drawdowns in the % off high chart below. This is year-to-date, since January 1.
Just for reference, this -6% decline looks more similar to May when I expand the time frame to 1 year instead of just year-to-date. We also see the October to December waterfall decline was a much deeper -20%.
Of course, if you look close enough, the pattern prior to the much steeper and deeper part of that fall looks similar to now, with the price trend testing the prior low, recovering, then falling sharply another -10%. I’m not pointing this out to say it will happen again, but instead that it’s always a possibility, so risk management is essential.
What is driving this decline?
Fear.
It’s that simple.
Some are afraid of another recession signaled by an inverted yield curve, others of the Trump Tweets, others by the Fed lowering interest rates or not doing it fast enough. I’ve heard some hedge funds are afraid China will invade Hong Kong, others are concerned of the China tariffs. Some people probably wake up afraid and fear everything that can possibly happen, as such, they experience it as if it did.
I prefer to face my fears and do something about them.
Investors have reached an extreme level of fear in the past few weeks as evidenced by the -6% decline in the stock index. We can also see this reflected in the investor sentiment poll. The AII Sentiment Survey shows optimism is at an unusually low level and pessimism is at an unusually high level for the 2nd consecutive week.
Such extreme levels of investor sentiment often proceed trend reversals. So, these extreme fear measures along with the breadth measures I shared yesterday, I’m not surprised to see the stock market reverse up sharply today.
Another interesting measure is the Fear & Greed Index, which is a combination of multiple sentiment indicators believed to measure investor sentiment. The Fear & Greed Index has reached the “Extreme Fear” level, so by this measure, fear is driving prices.
Over time, we can see how the Fear & Greed Index has oscillated up and down, swinging from fear to greed and back to fear again. I highlight the current level has reached the low point it typically does before it reverses up again, with the exceptions of the sharp panics in 2018.
I have my own proprietary investor sentiment models, but here I share some that are simple and publicly available. I’m not suggesting you trade-off of these, as I don’t, either, but instead use them to help modify your investor behavior. For example, rather than use these indicators to signal offense or defense, investors may use them to alert them to their own herding behavior. Most of the time, we are better off being fearful when others are greedy and greedy when others are fearful.
These measures aren’t quite robust enough to be timing indicators by themselves, my signals are coming from other systems and I’m using these to illustrate what’s driving it.
Over the past 12 months, as of right now the stock index is up 2.48%. That’s including today’s 1.5% gain.
Only time will tell if it holds the line, but as I’ve zoomed in to a 3-month time frame, we can see the first line of support that needs to hold.
We are long and strong at this point, so;
Giddy up!
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 and provides investment advice and portfolio management exclusively 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. 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 is 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. Use of this website is subject to its terms and conditions.
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.
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.
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.
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.
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.
Investor sentiment measures may be used as contrarian indicators. We expect the market to do the opposite of what the indicators are saying when they reach an extreme level of bullish/greed/optimism or bearish/fear/pessimism. Identifying extreme levels of positive or negative sentiment may give us an indicator of the direction the stock market is likely to trend next.
I observe when sentiment reaches overly optimistic levels like it did late 2017 into January 2018, the stock market trend trends down or at least sideways afterward. In reverse, after investor sentiment becomes extremely pessimistic, the stock market tends to trend back up.
Although extreme investor sentiment may be used as a contrarian indicator, I do not base my investment or tactical trading decisions on it by itself. I use investor sentiment measures and indicators to indicate and confirm my other signals of a potential trend change. For example, when bullish investor sentiment is rising from a lower level but not yet reached an extreme high, it’s just confirming trend following. However, when bullish sentiment reaches an extreme it warns me to be prepared for a potential countertrend. All those who want to buy may have bought, so buying enthusiasm may be exhausted. That’s what I observed in January 2018. After prices fall investor sentiment shifts to bearish and they fear more loss. Once the level of fear reaches an extreme it begins to suggest those who want to sell have sold and we could see selling become exhausted and a selling climax.
We have two types of investor sentiment measures: Polls and indicators.
Investor sentiment polls actually survey investors to ask them what they believe about the market. The AAII Investor Sentiment Survey has become a widely followed measure of the mood of individual investors. Since 1987, AAII members have been answering the same simple question each week:
“Do you feel the direction of the market over the next six months will be up (bullish), no change (neutral) or down (bearish)?”
The results are then consolidated into the AAII Investor Sentiment Survey, which offers us some insight into the mood of individual investors.
Bearish investor sentiment is negatively correlated with stock market index returns. Below I created a chart of the S&P 500 stock index with an overlay of the % bearish investor sentiment. On the bottom, I added the correlation between the S&P 500 and the % bearish investor sentiment. We can visually see there is a negative correlation between investors getting more bearish as stock prices fall. For example, few investors were bearish in 2014 into 2015 until the stock index fell -12% in August 2015, then the % of bearish investors spiked up. We also saw the % of bearish investors extremely low in January 2018 as the stock index reached an all-time high. After the stock index declined -20% at the end of 2018 we saw the % of bearish investors spike up again. As we enter 2019, the % of bearish investors is at a historical extreme high level so we may be observing a selling climax as the desire to sell gets exhausted.
Bullish investor sentiment is positively correlated with stock index returns, except after stock prices fall, then investors lose their optimism. In the chart below, we see the % of bullish investors trending up along with stocks 2014 into 2015, but then as prices fell late 2015 into 2016 they lose their optimism for stocks. We saw another spike to an extreme level of bullishness late 2017 into 2018 as the stock index reached all-time highs. The % of bullish investors declined with great momentum after prices fell sharply. As we enter 2019, the % of bullish investors is very low, leaving much room for the desire to buy to take over.
Investor sentiment surveys like AAII are useful tools to get an idea of extreme sentiment levels when selling pressure or buying enthusiasm may be becoming exhausted. However, their potential weakness is they are ultimately just polls asking people what they believe, not what they are actually doing. Regardless, they do seem to have enough accuracy to be used as a guide to confirm other indicators.
As I’ve observed extreme levels of investor sentiment and participation in the 2018 downtrend in global markets, I’ve shared these indicators several times. As we saw in the investor sentiment survey, the VIX spiked in 2015, then spiked again but to a lower high in 2016 as the stock index fell. The VIX spiked again in February 2018 as the S&P 500 quickly declined -10%. After prices trended back up implied volatility contracted all the way to the low level of 12. The stock index started to decline again, so the VIX once again indicated a volatility expansion. As we enter 2019, the CBOE S&P 500 Volatility Index VIX is at 25.42, just over its long-term average of 20. The VIX implies an expected volatility range of 25% over the next 30 days.
I’ve shared several observations the past few months of the Put/Call Ratio. The Put/Call Ratio is a range bound indicator that swings above and below 1, so reveals a shifting preference between put volume to call volume. When the level is high, it indicates high put volume. Since puts are used for hedging or bearish trades, I consider it a contrary indicator at extremely high levels.
The Equity Put/Call Ratio measures the put and call volume on equities, leaving out indexes. The Equity Put/Call Ratio spiked to a high level of put volume when it reached 1.13 on December 21, 2018, as the stock index was declining. The high Equity Put/Call indicated options trading volume was much higher for protective puts than call volume. The Equity Put/Call Ratio is considered to be mostly non-professional traders who tend to be more bullish, so it keeps call volume relatively high and the ratio low. Its high level has so far turned out to be a reliable short-term indicator of a short-term low in stocks. As we enter 2019, the Equity Put/Call Ratio is at .60, which is at a normal range. We normally see more call volume than put volume in the Equity Put/Call Ratio, so the ratio is its normal level as you can see in the chart.
The CBOE Index Put/Call Ratio is applied to index options without equity options. We believe professional traders and portfolio managers mostly use index options for hedging or directional positions. The total volume of the Index Put/Call Ratio is asymmetric toward puts for hedging purposes. As we can observe in the chart below, the current level at the beginning of 2019 is 1.09 dropping about 35% from it’s December peak at 1.67.
We can visually see the tendency in Index Put/Call is around 1 as the Equity Put/Call Ratio is around 0.60. Equity Put/Call Ratio has a more optimistic/bullish tendency as individual stock options are used more for bullish bets as index options are used more as for hedging.
The CBOE Total Put/Call Ratio combines both equity and index options to create a range bound oscillator that swings above and below 1. With the Total Put/Call Ratio, I believe the put bias in index options is offset by the call bias in equity options. The Total Put/Call Ratio spiked to its highest ever reading of 1.82 on December 20, 2018, as the stock index was entering the -20% “bear market” level. I consider a level above 1.20 to be bullish as it indicates an extreme in put volume over call volume. A reading below 0.70 is more bearish since there is an asymmetry between call volume over put volume. Above 1.20 is an elevated put trading volume. As a bet that stock prices will fall or hedge against them, buying put options is a bearish sentiment. Of course, some of the volume could have been traders selling puts which are a very speculative bullish bet, but since I pointed it out the stock indexes reversed up sharply, so I believe it turned out to be a reliable short-term indicator of a short-term low in stocks. As we enter 2019, the Total Put/Call Ratio is at .98 which is still high. We usually see more call volume than put volume, so the ratio is typically well below 1 as you can see in the chart.
There is no better indicator of a shift in investor sentiment than price action. No one believes that any more than me. The direction of the price trend is the final arbiter, and I’ve believed it over two decades. Any indicator that is a derivative of price or non-price trend economic data has the potential to stray far from the reality of the price trend. The price trend determines the value and the outcome of a position. As we enter 2019, the S&P 500 stock index has declined -20% off it’s September high and after a sharp reversal up since December 24th, it’s currently in a short-term downtrend, but at a level, the countertrend back up may continue.
Even if you don’t observe investor sentiment measures as an indicator or trade signal, it’s still useful to observe the extremes to help avoid becoming overly bullish or overly bearish and part of the herd. The herd tends to be wrong at extremes, and most investors tend to do the wrong thing at the wrong time. If I am to create better results, I must necessarily do the opposite of most investors.
As a tactical investment manager, I identify changes in price trends, inter-market relationships, investor sentiment, and market conditions aiming for better risk-adjusted returns. My objective is asymmetric investment returns, so I necessarily focus on asymmetric risk/reward positions, and that includes focusing on asymmetries between bullish and bearish investor sentiment.
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 popular stock indexes are now down about -5% year to date.
The popular stock indexes are now about -13% off their highs.
I don’t normally include the NASDAQ since it’s so overweight the Technology sector, but it’s down -17% off its high and the Russell 2000 small-cap index is down -19%. The year started off very strong and is ending with weakness so far.
I pointed out earlier this year that Emerging Markets and Developed countries stock markets were already in a bear market if we define it as -20% off highs. Here we see they are down even more than the U.S. stocks year to date.
I warned before that with interest rates rising, bonds may not provide the crutch they have in past stock market declines. That has been the case in 2018. Even with the long-term Treasury gaining recently from being down -12%, it’s still down -6% year to date.
Many investors are probably wondering what’s going to happen next. I said a week ago in Stock Market Observations that stocks have fallen far enough that “We would expect to see some potential buying support at these levels again.” For these popular stock indexes, they are now at the point of the February and April lows and reaching an oversold level by my momentum measures.
We are looking for signs that selling pressure is drying up as those who want to sell have been exhausted and new buying demand increases to take over. Some signs of stock prices reaching a low enough point to attract more buying than selling are observed in investor sentiment measures and breadth indicators.
A simple easy to follow gauge of investor sentiment is the Fear & Greed Index, which is a composite of seven Investor sentiment measures. The investor sentiment reached an “Extreme Fear” zone again.
Investor fear by this measure has been high for the past few months. At some point, we would expect to see those who want to sell have sold. However, if this stock trend becomes a bear market we would expect to see this gauge remain low for a long time. Although, the stock indexes will swing up and down along the way.
Another observation of investor sentiment reaching an extreme was last week’s AAII Investor Sentiment Survey. Last week pessimism spiked to its highest level since April 2013, while optimism fell to an unusually low level.
For some historical context, the % of bearish investors has reached the high level it did at the 2016 stock market low. When investor fear reaches such extremes, it’s a contrary indicator.
A bear market is a process, not an event. At -13% it’s hard to say if this will become a bear market, though there are some potential drivers that could cause stocks to fall more over time.
The first warning sign for the big picture is earlier this year the Shiller PE ratio for the S&P 500 reached the second highest level ever, with data going back before 1880.
The only two times the Shiller PE ratio for the S&P 500 had reached this “overvalued” level was 1929 and 1999. Of course, 1929 was followed by The Great Depression and 1999 was followed by the Tech Bubble Burst. The only time I pay attention to the PE ratio is for a big picture assessment of valuation when it reaches extreme highs or lows. At such a high level of valuation, we shouldn’t be surprised to see volatility and stocks decline. The unknown is if it keeps declining much more to reach an “undervalued” level at some point. So far, with -13% decline, the Shiller PE ratio for the S&P 500 has declined from 33 at the beginning of the year to 28 now. Twenty or higher is considered high, 10 or less is considered low. It is what it is.
A bear market is a process, not an event, which means the stock market will swing up and down along the way. For example, historical bear markets are made up of swings of -10%, +8%, -14%, +10%, each swing doesn’t make a higher high, but instead prints a lower high and lower lows. The good news is, the swings are potentially tradable. However, for those tactical traders who attempt to trade them, it isn’t easy and it doesn’t always feel good. These kind of periods are volatile, so a skilled tactical trader has to increase and decrease exposure to the possibility of gain and loss. For me, predefining risk is essential, but so is holding the predetermined exposure to give a trend room to play out.
Some potentially positive news is the breadth indicators suggest most stocks are participating in the downtrend. That doesn’t sound positive unless you realize as stocks get washed out on the downside the selling pressure is eventually exhausted, at least temporarily. Below is one indicator we observe to see what is going on inside S&P 500 stock index. It’s the percent of the 500 stocks in the index that are trending above their 50-day moving average. When this indicator is low, it signals stocks may be nearing a level of selling exhaustion as most of them are already in downtrends. However, if this does become an actual bear market of -20% or more, we’ll see this indicator swing up and down along with the price trend. At this point, it’s in the green zone, suggesting the stocks may be near the “washed out” area so we could see some demand take over supply in the days or weeks ahead.
As you can see below, the percent of stocks above their 50 day moving average has now reached the low level it did in February and back in August 2015 and January 2016 that preceded a reversal back up.
I shared my observations of this breadth indicator back in February when I explained it in more detail if you want to read it Stock Market Analysis of the S&P 500. I also shared it in October when the current downtrend started. In October, the percent of stocks above their 200 day moving average was still high and hadn’t declined much. That isn’t the case now. As you can see, even this longer term breadth indicator is now entering the green zone. As more stocks have already declined, it becomes more and more likely we’ll see selling exhausted and shift to buying demand as prices reach lower more attractive levels for institutional investors.
As you can see below, the percent of stocks above their 200 day moving average has now reached the low level much below February and now down to the levels reached in August 2015 and January 2016 that preceded a reversal back up in stocks.
Another indicator that measures the participation in the trend is the S&P 500 Bullish Percent index that I have been observing for over two decades. This is the percent of stocks on a Point & Figure buy signal, which often traces a pattern something similar to the 50 day and 200-day moving averages as it has the past four years. As we see below, this indicator is reaching the low level not seen since August 2015 and January 2016 that preceded a reversal back up.
At this point, we haven’t yet seen enough buying enthusiasm to overwhelm the desire to sell. But, many of these indicators I’ve been monitoring for nearly two decades are reaching a level we should see some shift at some point. If we don’t, the stock market may enter into a more prolonged and deeper bear market. However, historically lower lows are made up of cycle swings along the way, so we should still see at least some shorter-term uptrends.
I’m starting to hear a lot of “bear market” talk in the news and on social media, so I thought I would put the current decline into context. My mission isn’t to take up for the stock market, but instead to present the facts of the trends as they are. I was defensive at the beginning of the year and then added more exposure after prices fell. I predefine my risk by predefining my exits in all of my positions, so any exposure I have has a relatively short leash on how low I’ll allow it to go before I cut my loss short, rather than let the loss get large. I am never a market cheerleader, but because I was already defensive near the peaks, I may have the potential to take advantage of the lower prices. I’m almost always going to be a little too early or a little too late and that is fine. It’s never been perfect but has still achieved the results I want the past two decades.
To put the current decline into historical contacts, we can simply compare it to the last decline of -10% or more, which was around August 2015 and January 2016. For nearly two years, the stock index was range bound with no upside breakout.
Looking closer at the % off highs, we see the late 2015 decline was -12% and the first few months of 2016 was about -15%.
Here is 2018. So far, it isn’t actually as much of a decline.
Another interesting observation I’ll share is the trend in the CBOE S&P 500 Volatility Index (VIX). Below is the 2015 to 2016 period again with the S&P 500 in the top panel and VIX volatility index in the bottom panel. We see the VIX spiked up sharply around August 2015 when the stock market decline. However, when the stock market recovered the loss and then declined again to a lower low, the VIX index didn’t reach the same high level the second time. The volatility expansion wasn’t nearly as high even though the stock index reached an even lower low.
We are observing that same divergence in volatility this year. The VIX spiked over 100% when stocks fell -12% around February this year. The stock market recovered and printed a new high in September, then has since fallen -13% from that high. This time, however, the implied volatility VIX index hasn’t spiked up nearly as high.
What could it mean? When the VIX increases it is an indication of expected future 30-day volatility implied by the options on the stocks in the S&P 500. When the VIX increases, it means options traders are probably using options to hedge against market declines. I’m guessing it could signal that hedging and possible selling enthusiasm could be drying up. That seems to be what it suggested in 2015 to 2016 when it did the same, then the stock market trended up into 2017.
We’ll see how it all unfolds from here, but the stock market has clearly reached an inflection point. Stocks have trended down to a low enough level we should see some buying demand if it’s there. You can probably see why I believe markets require me to actively manage my risk through predefined exits and hedging to extract from it the asymmetric risk-reward I want.
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.
In the last observation I shared about the stock market, “The stock market trends up with momentum,” we saw the stock market reverse back up with strong momentum. The S&P 500 stock index had declined about -7% from its high, then reversed back up 3%. I discussed how investor behavior and sentiment drives market prices. Many investor sentiment measures signaled investor fear seemed to be in control, driving down prices. Volatility had spiked and then started to settle back down. Many individual stocks in the S&P 500 had declined enough to signal shorter-term downtrends, but then they reversed up. I closed by saying:
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.
The part I bolded with italics has turned out to be the situation this time.
Below is a year to date price trend of the S&P 500 stock index. As of today, my observation “the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low” is what we are seeing now.
I’ve always believed investment management is about probability and possibilities, it’s never a sure thing. The only certainty is uncertainty, so all we can do is stack the odds in our favor. As I said before, “After the test, we then find out if it breaks down or breaks out.”
The positive news is, investor sentiment measures are reaching levels that often precede short-term trend reversals back up.
The bad news is if the current trend becomes a bigger downtrend these indicators will just stay at extremes as long as they want. We have to actively manage our exposure to loss if we want to avoid large losses, like those -20% or more that are harder to overcome.
Down -10% is one thing, down -20% is another. Any investor should be willing to bear -10% because they will see them many times over the years. Only the most passive buy and hold investors are willing to bear the big losses, which I define as -20% or more.
Nevertheless, I see some good news and bad, so here it is. I’ll share my observations of the weight of the evidence by looking at relatively simple market indicators. I don’t necessarily make my tactical decisions based on this, but it is instead “market analysis” to get an idea of what is going on. Observations like this are intended to view the conditions of the markets.
Fear is the dominant driver.
The Fear & Greed Index tracks seven indicators of investor sentiment. When I included it a week ago, it was at 15, which is still in the “Extreme Fear” zone. The theory is, the weighting of these seven indicators of investor sentiment signals when fear or greed is driving the market. Clearly, fear is the dominant driver right now.
At this point, we can see investor sentiment by this measure has now reached the low level of its historical range. In this chart, we can see how investor sentiment oscillates between fear and greed over time in cycles much like the stock market cycles up and down.
I believe investor behavior is both a driver of price trends, but investors also respond to price trends.
Investor sentiment and price trends can overreact to the upside and downside and the herd of investors seems to get it wrong when they reach an extreme. We observe when these kinds of indicators reach extremes, these cycles are more likely to reverse. It is never a sure thing, but the probabilities increase the possibility of a reversal. But, since there is always a chance of a trend continuing longer in time and more in magnitude, it is certainly uncertain. Since there is always a chance of a bad outcome, I have my limits on our exposure to risk with predetermined exits or a hedge.
Speaking of a hedge.
I started pointing out my observation several weeks ago of a potential volatility expansion. If you want to read about it, most of the past few weeks observations have included comments about the VIX volatility index. Over the past few days, we’ve observed a continuation in the volatility expansion.
Implied volatility has expanded nearly 100% over in the past 30 days.
As a tactical portfolio manager, my first focus is risk management. When I believe I have defined my risk of loss, I become willing to shift from risk manager to risk taker. I share that because I want to point out the potential for hedging with volatility. Rather than a detailed exhaustive rigorous 50-page paper, I’m going to keep it succinct.
My day job isn’t to write or talk about the markets. I’m a professional portfolio manager, so my priority is to make trading and investment decisions as a tactical investment manager. I’m a risk manager and risk taker. If I never take any risk, I wouldn’t have any to manage. The observations I share here are just educational, for those who want to follow along and get an idea of how I see things. I hope you find it helpful or at least interesting. It’s always fun when it starts new conversations.
To keep the concept of hedging short and to the point for my purpose today, I’ll just share a simple chart of the price trend of the stock index and the volatility index over the past 30 days. The stock index has declined -8.3% as the implied volatility index expanded over 95%. You can probably see the potential for a hedge. However, it isn’t so simple, because these are just indexes and we can’t buy or sell the VIX index.
The purpose of a hedge is to shift the risk of loss from one thing to another. The surest way to reduce the possibility of loss is to simply sell to reduce exposure in the thing that is the risk. That’s what I do most of the time. For example, when I observed a potential volatility expansion, I reduced my exposure to positions that had the possibility of loss due to increased volatility. Once prices fall and volatility contracts, maybe we increase exposure again to shift back to risk-taking. If we take no risk at all, we would have no potential for a capital gain. So, tactical portfolio management is about increasing and decreasing exposure to the possibility of gain and loss. If we do it well, we create the kind of asymmetric risk/reward I aim for.
So, any hedging we may do is really just shifting from one risk to another, hoping to offset the original risk. Keep in mind, as I see it, a risk is the possibility of loss. I’ll share more on hedging soon. I have some observations about hedging and hedge systems you may find interesting.
Most stocks are participating in the downtrend. Below is an updated chart of the percent of the stocks in the S&P 500 that are above their 50-day moving average. If you want to know more about what it is, read the last observations. The simple observation here is that most stocks are declining.
Much like how we saw investor sentiment cycle and swing up and down, we also see this breadth indicator oscillate from higher risk levels to lower risk levels.
The good news is, at some point selling pressure does get exhausted as those who want to sell have sold and prices reach a low enough level to bring in new buying demand.
That’s what stock investors are waiting for now.
These are my observations. I don’t have a crystal ball, nor does anyone. I just predetermine my risk levels in advance and monitor, direct, and control risk through my exits/hedging how much I’m willing to risk, or not. We’ll just have to see how it all unfolds in the days and weeks ahead.
Only time will tell if this is the early stage of a bigger deeper downtrend or just another correction within the primary trend.
I hope you find my observations interesting and informative.
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.
Volatility is a measure of the frequency and magnitude of price swings up and down in a market or stock over a period of time.
We can measure volatility using two general methods:
The VIX Index measures the market’s expected future volatility based on options of the stocks in the S&P 500® Index. The VIX Index estimates expected volatility by aggregating the weighted prices of S&P 500 Index put and call options over a range of strike prices.
The last observation I shared of the trend and level of VIX was VIX Trends Up 9th Biggest 1-day Move. I pointed out the VIX level had been very low, and it was an observation of complacency. The VIX spiked up nearly 300% – a volatility expansion. Actually, we could call it a volatility explosion.
The current level of the VIX index has settled down to a lower historical level suggesting the market expects the future range of the price of the S&P 500 to be lower. Below is the current level relative to the past year.
Looking at the current level of 12 compared to history going back to its inception in 1993, we observe its level is indeed near its lowest historical low.
The VIX Index is intended to provide a real-time measure of how much the market expects the S&P 500 Index to fluctuate over the next 30 days. The VIX Index reflects the actual order flow of traders.
Since investors tend to extrapolate the recent past into the future, they usually expect recent calm markets to continue and violent swings to persist.
After the stock market declines and volatility expands, investors extrapolate that recent experience into the future and expect volatility to continue. Sometimes it does continue, but this time it gradually declined as the price trend became calmer.
When markets have been calm, traders and investors expect volatility to remain low. Before February, the VIX implied volatility had correctly predicted low realized volatility for months. But, both realized and expected volatility was so low that many investors were shocked when stock prices fell sharply, and volatility expanded.
When the market expects volatility to be low in the next 30 days, I know it could be right for some time. But, when it gets to its historically lowest levels, it raises situational awareness that a countertrend could be near. It’s just a warning shot across the bow suggesting we hedge what we want to hedge and be sure our risk levels are appropriate.
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.
Looking at the broad global markets, U.S. stocks are in a positive trend along with the U.S. Dollar. International stocks, commodities, and foreign currency are trending down.
With the directional trends and momentum being in U.S. stocks, though not without volatility, that has been our focus this year.
International stocks including both developed countries $EFA and emerging markets $EEM are trending down so far in 2018 as the U.S. Dollar $UUP is trending up.
The U.S. Dollar $UUP is trending similar to U.S. stocks $SPY in April.
The dollar has an inverse correlation with foreign currency like the Euro.
With the rising dollar $USD, gold $GLD is trending down even more than the Euro currency $FXE.
So, the overall broad observation of global macro picture is clearly a rising U.S. Dollar and U.S. stocks that are diverging from other markets.
Mike Shell is the Founder, and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios and 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.
A stock must be in a positive trend to earn a huge gain…
A stock must be in a downtrend to produce a large loss…
The common factor? the direction of the trend…
That’s what investors like about the concept of trend following.
We want to have capital in trends that are rising and out of trends that are falling.
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.
“Optimism among individual investors about the short-term direction of the stock market rebounded, rising above its historical average.”
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.
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. 
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.
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.
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
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 pessimism shifted to an unusually high level for the time this year. It spiked up from 24% bearish to 41%.
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.
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.
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.
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.
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.
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).
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.
Year to date, the divergence is more clear. Growth is positive, the blended S&P 500 stock index is flat, and Value is negative.
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.
Many investment professionals admit they are unable to “time the market.”
What is “market timing,” anyway? Wikipedia says:
Market timing is the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.
One reason they “can’t time the market” is they are looking at the wrong things. The first step in any endeavor to discover what may be true is to determine what isn’t. The first step in any endeavor to discover what may work is to determine what doesn’t.
For example, someone recently said:
“A bear market is always preceded by an economic recession.”
That is far from the truth…
The gray in the chart is recessions. These recessions were declared long after the fact and the new recovering expansion was declared after the fact.
The most recent recession:
“On December 1, 2008, the National Bureau of Economic Research (NBER) declared that the United States entered a recession in December 2007, citing employment and production figures as well as the third quarter decline in GDP.”
So, the economist didn’t declare the recession until December 1, 2008, though the recession started a year earlier.
In the meantime, the S&P 500 stock market index declined -48% as they waited.
While the recession officially lasted from December 2007 to June 2009, it took several years for the economy to recover to pre-crisis levels of employment and output.
The stock market was below it’s October 2007 high for nearly six years.
Economists declared the recession had ended in June 2009, only in hindsight do we know the stock market had bottomed on March 9, 2009. The chart below shows the 40% gain from the stock market low to the time they declared the recession over. But, they didn’t announce the recession ended in June 2009 until over a year later in September 2010.
Don’t forget for years afterward the fear the economy will enter a double-dip recession.
If you do believe some of us can predict a coming stock market decline or recession, it doesn’t seem it’s going to be based on the economy. Waiting for economics and economic indicators to put a time stamp on it doesn’t seem to have enough predictive ability to “time the market” to avoid a crash.
I suggest the directional price trend of the stock market itself is a better indicator of the economy, not the other way around. Then, some other signals begin to warn in advance like a shot across the bow.
But, for me, it’s my risk management systems and drawdown controls that make all the difference.
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 Mike Shell on Twitter @mikewshell.
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. 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 investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. 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 are 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 the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.
Looking at broad indexes for global macro trends, global stocks are flat for the year, bonds are down as much as 6%, commodities are recently trending up.
At this point, U.S. stocks continue to look like a normal “correction” within ongoing higher highs and higher lows (a bull market). In this case, a correction is just a countertrend of “mean reversion” that has “corrected” the prior upside overreaction.
What would change the trend? changing from a normal “correction” within ongoing higher highs and higher lows (a bull market) to lower lows and lower highs. In that scenario, it would be a change in the dominant trend.
Only time will tell how it all plays out.
Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.
The is no guarantee that any strategy will meet its objective. Past performance is no guarantee of future results. The observations shared are for general information only and are not intended to provide specific advice or recommendations for any individual.
“Don’t fight the tape.”
“Make the trend your friend.”
“Cut your losses and let your winners run.”
“These Wall Street maxims all mean the same thing—bet on price momentum. Of all the beliefs on Wall Street, price momentum makes efficient market theorists howl the loudest. The defining principle of their theory is that you cannot use past prices to predict future prices. A stock may triple in a year, but according to efficient market theory, that will not affect next year. Efficient market theorists also hate price momentum because it is independent of all accounting variables. If buying winning stocks works, then stock prices have “memories” and carry useful information about the future direction of a stock.”
It takes at minimum a full market cycle including both bull/bear markets to declare an edge in an investment management track record.
But we also have different regimes. For example, each bull market can be different as they are driven by unique return drivers. Some are more inflationary from real economic expansion driving up prices. Others are driven by external manipulation, like the Fed intervention.
I’ve been managing ASYMMETRY® Global Tactical for fourteen years. It’s an unconstrained, flexible, adaptable, go-anywhere global tactical program without the limitations of a fixed benchmark. I pursue absolute returns applying dynamic risk management and unconstrained tactical trading decisions across a broad universe of global currency, bonds, stocks, and commodities.
So, I can tell you the bull market 2003-07 was a regime of rising commodities, foreign currency, and international producers of commodities. In this bull market, U.S. equities have dominated. We can see that in the chart below. If your exposure up until 2008 was only U.S. stocks, you would be disappointed as Emerging Markets countries like China and Brazil were much stronger as was commodities. We can also see how those markets have lagged since the low in 2009.
Everything is impermanent, nothing lasts forever, so this too shall change eventually. Those who believe the next decade will be like the past do not understand the starting point matters, the return drivers, and how markets interact with each other. Past performance is never a guarantee of future results.
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.
Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.
Buying enthusiasm reversed from positive to selling pressure today after the first hour. I observed notable selling volume at the close, which was the opposite of what I pointed out last Thursday.The S&P 500 Stock Index was down -1.27% for the day.
I’ll also share that volume increased sharply during the -10% decline in the S&P 500 Stock Index earlier this month. No surprise, it was selling pressure after many months of buying enthusiasm, just an observation…
So far, the S&P 500 Stock Index has regained approximately half of its -10% loss earlier this month and is now up 2.64% for the year.
Since I pointed out that the stocks inside the S&P 500 has dropped to a much lower risk zone in Stock Market Analysis of the S&P 500, the % of stocks in the index above their 50 day moving average increased from only 14% in a positive trend to 55%. Today, 18% fewer stocks are above their 50-day moving averages.
None of this is yet suggesting a change of trend, but when stock popular stock indexes gain or lose more than 1% or so my plan is to update it here.
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.
Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.
I have recently found myself reminiscing about the late 1990’s – specifically the grand euphoric year of 1999. If you aren’t sure why then maybe you aren’t paying attention. Sometimes not paying attention is a good thing if it prevents you from following a herd off a cliff.
The four most expensive words in the English language are “this time it’s different.” – John Templeton
Lately, I’ve been reminiscing about the tech stock bubble, the .com’s, and how the Nasdaq QQQ replaced the Dow Jones Industrial Average as the favorite index by 1999. Then there were all the infamous statements like “you don’t understand the New Economy”. We’ve been talking about the funny commercials from the baby trader to the college-age guy helping the mature executive start trading online, to “Be Bullish”.
Do you remember Stuart and Mr. P? Back in 1999, there were traditional “stockbrokers” who were registered with a brokerage firm, who bought and sold stocks, bonds, and options for individual and institutional clients. If you were a stockbroker back then, like I was, you probably remember it well. Online trading was the beginning of the end for the traditional “stockbroker” firms earning a $200 commission to buy or sell 100 shares. The great thing about the evolution of online trading is it lowered trading costs dramatically. For someone like me who wanted to be a tactical money manager anyway, that was a great thing. I embraced it and went on to start my investment management company. But the point of this observation is the investor sentiment in 1999. The video below is amazing to watch 20 years later. But what fascinates me the most is how it reminds me of today; different subjects, same sentiment.
Watch:
That may remind you of some of the things we hear today.
Those type of commercials flooded the financial news and evening news channels in 1999. To be sure, below is a WSJ article printed about the “Let’s Light This Candle” ad on December 7, 1999. I’ll tell ya what… that’s about as close to the top as you can get.
So, I wondered, what happened to Stuart and Mr. P?
Stuart was helping Mr. P buy Kmart stock online. Kmart was then one of America’s leading discount retailers. The Kmart Corporation was the second largest U.S. discount retailer and major competitor to Walmart. Kmart filed for Chapter 11 bankruptcy protection in January 2002. Just two years after Stuart helped Mr. P buy shares online it filed for the largest ever retail bankruptcy. Kmart was later bought by Sears, which is now a failing company. At least Mr. P was wise enough to only buy 100 shares, young Stuart wanted him to buy 500 shares! They had no position size method to determine how much to buy based on risk, which would include a predefined exit. It is unlikely Mr. P had a predefined exit in place to exit the stock to cut the loss short. During that time, investors were only thinking about what to buy. They rarely considered how and when to exit a stock with a small loss to avoid a larger loss. After such a strong bull market, who is thinking about the risk of loss?
For those of us who remember, in the late 1990’s most investors weren’t just buying the largest retailers – they were buying technology. In hindsight, that period is now referred to as the “tech boom” or “tech bubble”. That’s because almost everyone wanted to buy tech stocks. Literally, even the most conservative seniors were cashing out bank CD’s to buy tech stock. And… I’m not even going to get into the .com stocks, most of which no longer exist from that time.
Whether you remember the trend as my friends and I do or not, we can use historical price charts to see what happened. Below is the Technology Select Sector SPDR® ETF since its inception 12/16/1998 to today. I’m starting with the full history to see the initial gain, before the waterfall decline. The Technology Select Sector SPDR® Fund seeks to:
“Provide precise exposure to companies from technology hardware, storage, and peripherals; software; diversified telecommunication services; communications equipment; semiconductors and semiconductor equipment; internet software and services; IT services; electronic equipment, instruments, and components; and wireless telecommunication services.”
Those were the most popular sectors, aside from the actual Internet stocks.
Below is what happened from December 9, 1999, when WSJ printed the article about the ad because it was so interesting and popular, to now. After nearly 20 years an investor buying the diversified tech sector would have just recently realized a profit, assuming they held on for 19 years.
Here is what that -80% drawdown looked like that lasted 19 years.
“Those who cannot remember the past are condemned to repeat it. “
George Santayana
This is a kickoff of a series of articles on this topic I have in queue on current global market conditions. Stay tuned…
Mike Shell is the founder of Shell Capital Management, LLC, a registered investment manager and portfolio manager of ASYMMETRY® Global Tactical.
If the U. S. Government shuts down, it will be the 19th time. Looking at the table below, it doesn’t seem a big deal. The table shows the 18 prior government shutdowns going back to 1976. It lists the start and end date of the shutdown and the gain or loss for the S&P 500 stock index. The average is only a -0.60% loss from beginning to end of the shutdown.
But, here are some considerations:
1. It is too small of a sample size to draw a statistically significant inference. Basic probability needs 30 data points.
2. It only shows the gain/loss from beginning and end of the shutdown.
3. It doesn’t show what happened before and after those dates. Was there more movement/drawdown before or after?
4. It doesn’t show what happened in between the start and end date so it may have been worse.
5. It doesn’t consider market stage at the time of shutdown. Was it overvalued and overbought? Or was it undervalued and oversold?
The truth is; anything can happen.
We don’t know for sure how it will play out. With such a small sample size of prior events and without factoring in the market conditions at the time, what it did in the past doesn’t provide us with a good expectation.
The current condition: if the government shuts down this time:
1. It will be when the U.S. stock market is at the second most expensive fundamental valuation, ever.
2. When investor and advisor bullish sentiment has reached record highs, at this point a contrary indicator.
3. As recent momentum indicators are at the highest levels ever seen before, at this point a contrary indicator.
My solution? always be prepared that anything can happen.
I know how much risk I’m willing to take given the possible outcomes and define my risk by knowing when I’ll hedge or exit.
Mike Shell is the founder of Shell Capital and the Portfolio Manager of ASYMMETRY® Global Tactical.
This morning a financial planner who knows we are the investment manager to wealthy families asked me a great question:
“What do wealthy people do differently?”
I thought I would just sit here and write it out. These are my own observations over a few decades.
First, let’s define “wealthy”.
I’m going to define “wealthy” as someone who has already achieved “freedom”. Notice I said “freedom”, not just “financial freedom”. I’ve asked thousands of people over the past two decades “what is important about money to you?”. Ultimately, the question leads to one single word: “freedom”. So, there doesn’t seem to be a need to add “financial” in front of “freedom”. But, that isn’t to say you can’t have plenty of money without much freedom. You could say “Some people have far more money than they ever need but they still don’t enjoy their freedom because they keep working for more”. You may consider that person is still getting what they want. Some people just want to produce, and they never stop. They are still free. They have the freedom to keep doing what they love doing. In fact, some wealthy people are driven to create more wealth for a charity. No matter what our goals are in life, traveling, relaxing, time with family and friends, helping others, having enough capital to do what we want seems essential.
Having enough money to do what we want, when we want, seems to be the primary goal of most of us.
So, I define “wealthy” as someone who has already achieved “freedom”, regardless how he or she chooses to enjoy his or her freedom.
What do these people do differently than those who haven’t accumulated enough capital to say they are “wealthy”?
1. They save and invest money. The first thing that I have observed is that they simply save part of their income and invest it.
a. Save: They save it because they don’t spend more than they should. They save a large amount of themselves to use later. Even if they earn $X a year, they don’t the most they can for their home or carts. For example, a person earning $1 million a year may live in a $1 million neighborhood and a neighbor who earns $200,000 a year. Who do you think will be “wealthy”? One is stretched, the other is saving.
b. Invest: People who achieve “freedom” and the “wealthy” status don’t stop and just saving money in a bank account, they invest it. Wealthy people take the time to invest their money. Most of them invest with an investment manager who is fully committed to investment management.
2. Wealthy people care about their money. I know a lot of wealthy people, and I know just as many who aren’t. Those who are wealthy save and invest money, those who don’t spend it. As investment management clients, wealthy families are the first to complete forms, etc. as needed because they care about their money. They also appreciate investment managers who are on top of things as they would be.
3. Wealthy people are focused on that ONE thing they do best. Just like the book The ONE Thing: The Surprisingly Simple Truth Behind Extraordinary Results says: they are focused. If they are a Physician, they focus on being a great Physician. If they own a company, they focus on their business. If they are a country music artist, they focus on being the best they can be. If they are an engineer, that’s their focus. They do what they do best and they find other people to do the things they don’t want to do like lawn maintenance or whatever. If you want to earn more money to save and invest, focus on what earns you the most and pay others for the things you aren’t so great at or don’t want to do.
4. They take some risks and manage their risk. To achieve wealth, we have to be both risk-takers and risk managers. If we take no risks in life, we’ll have no chance of reward. Not graduating from college has some risks, but so does attending. Who we marry, how we title our assets, how we insure our assets, and how we manage our assets all have risks and the potential for reward. Wealthy people tend to take risks in that one thing they are best at. They go “all in”. But wealthy people also direct and control their risks. They try to take good risks that are worth taking. It doesn’t matter how much wealth we accumulate if we aren’t able to keep it. For example, many people can remember how much wealth they created on paper up to 2000 only to see it cut in half. They did it again up to 2007 through 2009, and it took years to break even. Wealthy people know to realize a real profit, you have to take a profit. To avoid a large loss, we have to cut losses off at some point. Proper planning and risk management are essential.
5. Everything is relative, but yet it isn’t to them. I know business owners as well as Physicians who I consider wealthy as well as musicians, and athletes. But, you don’t have to earn $500,000 a year all your life to become wealthy. You don’t have to earn it all in a short time, either. I know people who have a total $500,000 invested who are wealthy. They have “enough”, for them. Depending on the lifestyle, others may not become wealthy until they have over $5 million if they spend a few hundred thousand a year traveling, etc. I also know families with several hundred million. Everything is relative, but wealthy people don’t compare their wealth and assets to others. They aren’t “keeping up with the Joneses”. People who do that often have large debts because they buy things they can’t afford with money they don’t have. Or, they save and invest less. Wealthy people don’t buy a new car or house because their friend does, or compare their investment account to others. Wealthy people may be more introverted when it comes to personal finance – their focus is on their own family needs.
What do the wealthy do differently? They discover how much capital they need to enable the freedom to do what they want when they want, whatever that may be. Income alone, or the neighborhood we live in, or the cars we drive, or memberships don’t signal that we are wealthy. Some wealthy people are still operating their business, practice, or “working”. A distinction is that they want to and they could choose to do something else with their time if they want. Wealthy families have saved and invested enough money to have achieved freedom. To do that, they focus on the thing they do best. They delegate the other stuff to someone else. They care about accumulating and managing their money and managing their risks. They appreciate investment managers and wealth managers who help them do it.
In “Relative Strength can be a source of conflict for Tactical Traders” I explained how two different momentum indicators are in conflict with each other and can lead to conflict in tactical trading decisions. Tactical traders may use many different indicators and methods to determine whether to enter, hold, or exit a position. If we look at two conflicting indicators like this, we have to avoid becoming conflicted ourselves.
To avoid the conflicts, define clearly what they are and how to use them. To do that, I’m going to mix up a bowl of Physics and Psychology.
The indicators essentially represent the same thing. They apply a different algorithm, but both are momentum measures that determine the speed of change in price movements. A key difference is that the basic Relative Strength I used is a simple price change over a period. That simple Relative Strength algorithm simply compares the price change over a period to determine which trends are stronger and which are weaker. Tactical Traders using this method of Relative Strength expect the stronger trends will continue to be stronger and the weaker trends will continue to be weaker. A trend in motion is expected to continue in that direction until some inertia comes along and changes it. You may recognize this from Physics:
Newton’s first law of motion states that “An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.” Objects tend to “keep on doing what they’re doing.” In fact, it is the natural tendency of objects to resist changes in their state of motion. This tendency to resist changes in their state of motion is described as inertia.
Inertia: the resistance an object has to a change in its state of motion.
We can say the same about investor behavior and beliefs when we look at confirmation bias.
Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses.
That psychological bias is similar to the physics law of motion;
“Objects tend to keep on doing what they’re doing. In fact, it is the natural tendency of objects to resist changes in their state of motion.”
Investor and trader behavior and Confirmation Bias seems to agree with the first law of motion.
You can probably see how we may develop our beliefs because of our environment. If we observe over time the natural tendency of objects to resist changes in their state of motion then we may expect a trend to continue.
It gets more interesting. According to The Physics Classroom:
Newton’s conception of inertia stood in direct opposition to more popular conceptions about motion. The dominant thought prior to Newton’s day was that it was the natural tendency of objects to come to a rest position. Moving objects, so it was believed, would eventually stop moving; a force was necessary to keep an object moving. But if left to itself, a moving object would eventually come to rest and an object at rest would stay at rest; thus, the idea that dominated people’s thinking for nearly 2000 years prior to Newton was that it was the natural tendency of all objects to assume a rest position.
So, up until Newton’s first law of motion, people believed trends would eventually end instead of continue. In that same way, some people look for and expect recent price trends to change rather than continue.
We have discovered two different beliefs.
A Tactical Trader using Relative Strength based on the rate of change assumes that trend speed and direction will continue into the future. This is more in agreement with Newton’s first law.
A Tactical Trader using the Relative Strength Indicator, an oscillator, assumes that trend speed and direction will oscillate between a range. If it reaches “oversold” it may reverse back up and if it reaches “overbought” it may reverse back down. This is more like the Physics beliefs prior to Newton’s first law when they expected a trend or motion to change.
To avoid conflicts between these two concepts and indicators, I define them separately as Trend Following and Countertrend.
Trend Following systems are methods that aim to buy securities that are rising and sell securities that are declining. Trend following is directional – it focuses on the direction of prices. Not all measures of Relative Strength are directional, but the one I used is. I simply ranked the sectors based on their price change over 3 months. That is an absolute ranking, but also a relative ranking. I may require the price change to be positive to enter a position. Some Relative Strength methods are only relative, so they don’t require a positive trend. They may enter the sectors that have a better price change over the period even if it’s negative.
Countertrend systems aim to bet against the recent price trend for the purpose of pursuing a capital gain or for hedging. In a strongly rising market, a countertrend strategy may believe the price is more likely to reverse. For example, the RSI is “overbought.” In a declining market, a countertrend strategy may indicate the trend is likely to reverse back up. For example, RSI is “oversold.” The risk is, an oversold market can keep trending lower and an overbought market may keep trending up!
I believe there are directional trends that are more likely to continue than to reverse – so I apply Trend Following to them. That necessarily means I believe investors may underreact to new information causing the price trend to drift gradually over time to match supply and demand.
I also believe that trends can reach an extreme, especially in the short run, by overreacting to information or extremes in sentiments like fear and greed. Because I have observed trends reaching an extreme, I may apply overbought and oversold methods for countertrend trading.
When I see the chart below, I think:
“The trend is up, it has moved up fast enough to be overbought in the short term, so it may pull back some and then the trend may resume to the upside”.
I combine the two, rather than them necessarily being in conflict with each other. I believe the high RSI number is confirming the strong trend, but I also believe it suggests it may not be the best entry point if you care about entering a position that may decline a few percent after you enter it.
So, I believe both of these systems can be applied at different times depending on the market state of the trend type. When a price trend is oscillating up and down over time but not necessarily making a major new high or low, a Countertrend method may capture profits from those swings. When a trend is moving up or down for a prolonged period that same Countertrend system may catch some of the profits and miss some as well. That is because it expects the trend to reverse at certain points and it doesn’t. However, a Trend Following system may better capture the overall trend when it keeps trending. But, none of them are perfect. If a Trend Following system captures the bigger trend it also means it will likely participate in a drawdown when the trend does end. If the Trend Following algorithm is loose enough to ride the trend without whipsaws, it will also be loose enough to lose some gains when the trend does change to the other direction.
If Tactical Traders and investors have useful definitions like these and can apply these different methods to different types of markets, with the right mindset and expectations we can avoid the conflicts.
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.
Relative Strength can be a source of conflict for Tactical Traders. I was talking to another tactical trader who manages a hedge fund. He said:
“Industrials are a leading sector, but it’s overbought”.
Relative Strength is a simple measurement to determine which stock, sector, or market has trended up the most over a period of time. For example, when we rank U.S. sectors over a period of 3 months to see which sectors have been trending the strongest, we see sectors like Financials, Energy, Materials, and Industrials have been the leaders over the past three months. Of course, past performance doesn’t necessarily indicate it will continue into the future. As with any trend indicator, Relative Strength is always looking at the past, never the unknowable future.
To see a different visual, below is how those same sectors appear in a line chart over the past 3 months. We observe that most of the sectors have trended in a wide range over the past few months.
When ranked by Relative Strength, the Industrial Sector is a leader compared to other sectors and its directional trend can also be seen in its price chart.
No, wait.
Now that I’ve pulled the chart up: The Industrial sector is overbought right now based on the Relative Strength Index. I highlighted the indicator over 70 with the red line.
So, one “Relative Strength” indicator says it’s in a strong relative trend, the other suggests its “overbought”.
These two indicators sound the same, but they are different, but also the same. It depends on what you think it represents. Both of them actually represent the same thing, but the expectation from them is the opposite.
Relative Strength as I used above, is just a simple comparison of the price trends over the past 3 months, or whatever time frame you want to use.
The Relative Strength Index is a momentum oscillator that measures the speed and change of price movements. That doesn’t sound much different than Relative Strength. The equation is different. The way it is used is different. RSI oscillates between zero and 100. The default time frame is only 14 days. Without writing a book on it, I’ll share that RSI is intended to capture the shorter term swings in a price trend. Since it’s using 14 days, it’s assuming a cycle of 28 days.
When the RSI exceeds 70 it’s considered “overbought” because, mathematically, it has moved a little too far, too fast. When it gets “overbought” it’s expected to either drift sideways for some time or reverse back down. We may indeed observe the price trend stalling at overbought levels. The trouble is, it isn’t perfect. A strong trending price with a lot of inertia can continue trending up and just get more and more overbought. I find that investors who pay a lot of attention to it are concerned their profit will be erased, so they are looking to take profits when it appears overbought.
When the RSI declines below 30 it’s considered “oversold” because, mathematically, it has moved down a little too far, too fast. When it gets “oversold” it’s expected to either drift sideways for some time or reverse back up. We may indeed observe the price trend stalling at oversold levels. The trouble is, a waterfall declining price trend with a lot of inertia like panic can continue trending down and just get more and more oversold. Buying oversold markets, sectors, or stocks can lead to profits, but it’s like catching a falling knife. When I buy oversold markets, I focus on the high dividend yield positions whos yield gets higher as the price falls.
Tactical traders use many different indicators and methods to determine whether to enter, hold, or exit a position. If we look at two conflicting indicators like this, we have to avoid becoming conflicted ourselves. Many tactical traders may experience Confirmation Bias, looking for an indicator that agrees with what they already believe.
So, let’s look at that chart again. On the one hand, it’s trending up! On the other hand, it’s overbought! Will the trend continue or will it reverse down?
We don’t know, but different tactical traders use different methods to enter, hold, and exit positions. I know tactical traders who use only Relative Strength. I know others who mainly use RSI. They are buying and selling each other’s positions and both of them could be profitable overall. If you don’t like to enter a position that may decline in the weeks ahead you may want to avoid high RSI “overbought” markets if you believe they may decline in the short term. If you are a trend following purist who loves to buy new breakouts you’ll ignore the RSI and instead realize a high RSI indicators a strong trend and go for it. Said another way: do you fear missing a trend or fear losing money short term.
It’s easy to say “Don’t get conflicted and biased!” but another to shed more light on the conflict.
Tomorrow I’m going to share with you how I see it.
Stay tuned.
Read Part 2: Resolving Conflicts with Relative Strength
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.
Someone was talking about how much the stock market is “up”.
However, it’s the exit that determines the outcome.
When someone talks about being “up” that doesn’t mean anything unless they have sold to realize the profit.
If they haven’t sold, it’s the markets money. The market may giveth, but it can also taketh away. Market gains are just market gains. To realize a profit, we have to sell.
Open profits aren’t yet realized.
Open profits may never be realized.
Open profits may be evaporated by later losses.
Closed profits are ours. When we exit and take a profit, we’ve realized the gain and have the cash to show for it.
To be sure, let’s look at the last 20 years. It’s hard to believe that a data point of 1997 is now 20 years ago! It seems like yesterday to me. Talking about 1997 may sound ancient now, but it wasn’t so long ago. The late 1990’s was one of the strongest cyclical bull markets in history. The S&P 5oo stock index gained over 200% in five years! The sharp gains of the late 1990’s inspired even the oldest bank savers to cash in CD’s that were paying 5% to 7% for the chance for high profits.
Only in hindsight do we know what happened next.
The essential concept investors must understand is not only how capital compounds, but also the math of loss.
Losses are asymmetric. In fact, losses are more asymmetric than gains.
That is, losses compound more exponential than gains.
Losses are exponential. As they get larger, it takes more gain to recover the loss to be back to even.
That’s why we don’t have to capture 100% of a gain to result in the same or better return if the downside loss is limited. When we avoid much of the downside, we simply don’t need to risk so much on the upside to compound capital positively. And, if we don’t have large losses on the downside investors are less likely to tap out with losses. Those concepts are essential to understand. It doesn’t matter how much the return is if the downside is so large they tap out before the gain is realized.
In the chart below, we can see how the math works.
A -10% loss takes +11% to recover. A 20% loss takes +25% to recover. Beyond -20%, the losses become more asymmetric and exponential. A -30% loss needs a +43% to get back to even. At -40% you need +67% to regain. That’s why losses in the -50% range as we’ve seen twice over the past 15 years are so devastating to life plans. At -50% you need +100% just to recover the loss and get back to breakeven. If your loss is -60%, it’s +150% to recoup. So when you hear people bragging about the stock market gains since 2009, don’t forget the other side of the story. It’s the other side the makes all the difference. How many years of staying fully invested in risky markets did it take to recover the loss?
Let’s look at how this matches up with real price trends we’ve observed over the past 20 years.
Below we see the late 1990’s gains more than erased by the sharp decline from 2000 to 2002. But keep in mind, while the decline was a sharp one at -50%, the decline was made up of many swings up and down along the way. The swings of lower highs and lower lows swayed many investors back “in” as those swings up along the way made them think the low was in and it was a “buying opportunity”. They did that just in time for the next down move. Avoiding bear markets isn’t as simple as exiting near the peak and reentering near the low. It’s far more complicated. Investors fear missing out during every 10% to 20% upswing, then they fear losing more money after every -10% to -20% downswing. But, the point here is that the large uptrend was erased by the later downtrend. What happens along the way brings additional challenges.
After the low around 2003, a new cyclical bull market began. As we know in hindsight, it lasted until October 2007. In October 2007, investors were pretty optimistic again and maybe a little euphoric. Stocks had gained over 100% from the bear market low and they wanted more stocks. It didn’t take long for a decline large enough that more than erased all the gains they were so excited about.
In fact, not only did that bear market erase the gains of the cyclical bull market that started in 2002, it also erased all of “The Tech Bubble” gains going back to 1995! By 2009 the past fourteen years was at a loss for stock index investors.
Even the largest uptrends have been erased by the later downtrends. This has happened many times in stock market history.
It doesn’t matter how much the stock market had gained. It only mattered if the profits were realized. Otherwise, it was just a rollercoaster.
You can probably see why I say that markets have profit potential, but because they don’t always go up, they require risk management. It’s why I actively manage risk and apply directional trend systems intended to capture profits and avoid significant losses.
I observed many headlines pointing out that March 9th is the 8th anniversary of the current bull market in U.S. stocks.
The rising trend in stocks is becoming one of the longest on record. It is the second longest, ever.
Looking at it another way, March 9, 2009 was the point that stock indexes had fallen over -50% from their prior highs.
Since most of the discussion focuses on the upside over the past 8 years, I’ll instead share the other side so we remember why March 9, 2009 matters.
‘Those who cannot remember the past are condemned to repeat it.’
– George Santayana
When investors speak of the last bear market they mostly call it “2008” or “o8”.
However, the end of the last bear market was actually March 9, 2009 and the beginning was October 2007.
Below is a chart of the S&P 500 stock index from October 9, 2007 to March 9, 2009. The price decline was -56%.
No one knew that March 9, 2009 was the lowest it would go. It could have gotten much worse.
Talking only about the gains since the low leaves out the full story.
When we research price trends, we must necessarily consider the full market cycle of both rising and falling trends. For example, below is the price trend since the peak nearly 10 years ago on October 9, 2007. Even after such a large gain, the Risk-to-Reward Ratio isn’t so good if you had to hold through the big loss to achieve it. That is, investors had to experience -56% on the downside for how much gain?
It isn’t the upside that causes so much trouble, it’s the downside.
That’s why we must manage risk to increase and decrease exposure to the possibility of gain and loss.
“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.
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.
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.
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.
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.
In Asymmetric Volatility, I used the range of weather temperatures to show that volatility is how far data points are spread out.
While it’s 72 degrees and sunny in Florida it can be below freezing in Boston with snow on the ground.
We observe asymmetric volatility in equity markets, too.
The equity market tends to crash down, but drift up. That is, uptrends tend to drift slower and less steep, and downtrends tend to fall faster and sharper and can become waterfall declines. We observe fewer geysers than waterfalls.
The drivers of this market dynamic seem to be mainly based on behavior and a reaction to price trends.
I could add that leverage has an impact, too. As markets have gone up for a while investors are more likely to use leverage to “get more aggressive”. Leverage levels tend to be highest at peaks. But, leverage and volatility feedback tend to be linked to panic selling leading to selling pressure. Prices fall more because they are falling.
I believe that upward price trends are primarily driven by underreaction to information. Even if we all get the same information at the same time, but we respond to it differently and at different times. Some get in the trend sooner, others enter later, some even wait until the end (and use leverage!).
Investors may underreact in downtrends, too. Many investors may not react to a loss of -5%, but -10% they may start to pay more attention and -20% some may panic. The deeper the fall, the more investors are likely to tap-out. By the time the stock market is down -20%, many may be selling to cut their loss. As selling pressure builds, selling leads to more selling as prices fall. If you are bold and -20% isn’t enough to tap you out, maybe -50% is.
If you are bold and -20% isn’t enough to tap you out, maybe -40% is. Or, -50%. I think everyone has a tap-out point. It could be losing it all.
Here is an example you may remember.
As the price trend made lower highs and lower lows, selling pressure continued and it led to a waterfall panic level decline. This kind of decline is what many “risk measurement” systems fail to acknowledge. Actually, they intentionally ignore them. If you use a risk measurement system that says it has a “95% Confidence Level”, these downtrends are the 5% it ignores. It acts like they won’t happen. It even does it on purpose.
That’s the very move you want to avoid.
You can probably see why I believe it is necessary to actively manage risk and apply drawdown control.
For the record, the period above wasn’t the full downtrend. I often see that period misquoted as “2008”.
It wasn’t just 2008.
The S&P 500 was just down -37% in the calendar year 2008.
The full decline was actually -55%. It began at the peak in October 2007 and didn’t end until March 2009.
It began at the peak in October 2007 and didn’t end until March 9, 2009.
2009 ended positive, so many people don’t include it when they speak of this last bear market. Below is January 1, 2009, to March 9, 2009. It continued to decline nearly -30% in those two months after 2008.
Beware of those who understate the historical downside and the potential for downside.
They are the same people who will experience it again.
– Richard Dennis
Many studies show that investors have poor results over the long haul including both bull and bear markets. For example, DALBAR has been conducting their annual Quantitative Analysis Of Investor Behavior study for 22 years now.
DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has been measuring the effects of investor decisions to buy, sell and switch into and out of mutual funds over both short and long-term time frames. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.
Their goal of QAIB is to improve investor performance by pointing out the factors that influence behaviors that determine the outcome of investment or savings strategies. They conclude individuals have poor results for two primary reasons:
If someone doesn’t save and invest some of their money, they’ll never have a chance to have good long-term results. However, they find the biggest reason for poor results by investors who do invest in the markets over time is investor psychology. Investors tend to do the wrong thing at the wrong time, especially at market extremes.
The chart below illustrates how investors tend to let their emotions lead them astray. The typical “bull market” for stocks may last four or five years. After investors keep hearing of rising market prices and headlines of “new highs” they want to invest more and more – they become euphoric. The may get more “aggressive”. However, those gains are in the past. Market trends are a good thing, but they can move to an extreme high (or low) and then reverse. Investors feel euphoria just as the stock market is getting “overvalued” at the end of a market cycle.
Look at that chart: what big trend do you think happens next?
Source: Investing and Emotions
On the downside, investors panic after large losses. There are many ways that investors get caught in this loss trap. For example, some are told to “stay in the market” so they hold on beyond their uncle point and then tap out. After they sell at much lower prices, they are too afraid to “get back in.” They are “Panic-Stricken.” They don’t discover the actual risk of their passive asset allocation until it’s too late and their losses are larger than they expected.
Investors need to know their real tolerance for loss before the loss happens. Then, they need to invest in a program that offers a matching level of risk management, so they don’t lose so much they tap out and lock in significant losses. If they reach their uncle point and tap out, they have an even more difficult challenge to get back on track.
You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple. – Warren Buffett
The chart above shows twenty-one years of the historical return of the S&P 500 stock index. Look at the graph above to see the points this happens. It shows an idealized example of investor emotions as prices trend up and down. As prices trend up, investors initially feel cautious, then hopeful, encouraged, positive, and as prices move higher and higher, they feel confident and thrilled to the point of euphoric. That’s when they want to get “more aggressive” when they should be doing the opposite. The worst investors actually do get more aggressive as they become euphoric at new highs, and then they get caught in those “more aggressive” holdings as the markets decline -20%, -30%, -40%, or more than -50%.
After such investment losses investors first feel surprised, then as their losses mount they feel nervous, then worried, then panic-stricken. But this doesn’t happen so quickly. You see, larger market declines often take a year or two to play out. The most significant declines don’t fall in just a few months then recover. The significant declines we point out above are -50% declines that took 3 – 5 years or more to get back to where they started. So, they are made up of many swings up and down along the way. If you look close at the chart, you’ll see those swings. It’s a long process – not an event. So few investors notice what is happening until it’s well in the past. They are watching the daily moves (the leaf on a tree) rather than the bigger picture (the forest).
So, investors get caught in a loss trap because the swings along the way lead them astray. Their emotions make them oscillate between the fear missing out and the fear of losing money and that’s why investors have poor results over a full market cycle. A full market cycle includes a major peak like the Euphoric points on the chart and major lows like the Panic-Stricken points. Some investors make their mistakes by getting euphoric at the tops, and others make them by holding on to falling positions too long and then panicking after the losses are too large for them.
At Shell Capital, I manage an investment program that intends to avoid these mistakes. I prefer to avoid the massive losses, so I don’t have panicked investors. And, we don’t have to dig out of large holes. That also necessarily means we don’t want to get euphoric at the tops. I want to do the opposite of what DALBAR finds most people do. To do that, I must necessarily be believing and doing things different than most people – a requirement for good long term results. But, creating exceptional investment performance over an extended period of ten years or more isn’t enough. We also have to help our investor clients avoid the same mistakes most people make. You see, if I am doing things very differently than most people, then I’m also doing it at nearly the opposite of what they feel should be done. Our investors have to be able to deal with that, too.
If you are like-minded, believe what we believe, and want investment management, contact us. This is not investment advice. If you need individualized advice, please contact us
Source for the chart: BlackRock; Informa Investment Solutions. Emotions are hypothetical and for illustrative purposes only. The S&P 500 Index is an unmanaged index that consists of the common stock of 500 large-capitalization companies, within various industrial sectors, most of which are listed on the New York Stock Exchange. Returns assume reinvestment of dividends. It is not possible to invest directly in an index. Past performance is no guarantee of future results. The information provided is for illustrative purposes only.
“The essence of investment management is the management of risks, not the management of returns. Well-managed portfolios start with this precept.”
– Benjamin Graham
The problem is many portfolio managers believe they manage risk through their investment selection. That is, they believe their rotation from one seemingly risky position to another they believe is less risk is a reduction in risk. But, the risk is the exposure to the chance of a loss. The exposure is still there. Only the perception has changed: they just believe their risk is less. For example, for the last thirty years, the primary price trend for bonds has been up because interest rates have been falling. If a portfolio manager shifts from stocks to bonds when stocks are falling, bonds would often be rising. It appears that trend may be changing at some point. Portfolio managers who have relied on bonds as their safe haven may rotate out of stocks into bonds and then their bonds lose money too. That’s not risk management.
They don’t know in advance if the position they rotate to will result in a lower possibility of loss. Before 2008, American International Group (AIG) carried the highest rating for an insurance company. What if they rotated to AIG? Or to any of the other banks? Many investors believed those banks were great values as their prices were falling. They instead fell even more. It has taken them a long time to recover some of their losses. Just like tech and telecom stocks in 2000.
All risks cannot be hedged away if you pursue a profit. If you leave no chance at all for a potential profit, you earn nothing for that certainty. The risk is exposure to an unknown outcome that could result in a loss. If there is no exposure or uncertainty, there is no risk. The only way to manage risk is to increase and decrease the exposure to the possibility of loss. That means buying and selling (or hedging). When you hear someone speaking otherwise, they are not talking of active risk management. For example, asset allocation and Modern Portfolio Theory is not active risk management. The exposure to loss remains. They just shift their risk to more things. Those markets can all fall together, as they do in real bear markets.
It’s required to accomplish what the family office Chief Investment Officer said in “What a family office looks for in a hedge fund portfolio manager” when he said:
“I like analogies. And one of the analogies in 2008 brings to me it’s like a sailor setting his course on a sea. He’s got a great sonar system, he’s got great maps and charts and he’s perhaps got a great GPS so he knows exactly where he is. He knows what’s ahead of him in the ocean but his heads down and he’s not seeing these awesomely black storm clouds building up on the horizon are about to come over top of him. Some of those managers we did not stay with. Managers who saw that, who changed course, trimmed their exposure, or sailed to safer territory. One, they survived; they truly preserved capital in difficult times and my benchmark for preserving capital is you had less than a double-digit loss in 08, you get to claim you preserved capital. I’ve heard people who’ve lost as much as 25% of investor capital argue that they preserved capital… but I don’t believe you can claim that.Understanding how a manager managed and was nimble during a period of time it gives me great comfort, a higher level of comfort, on what a manager may do in the next difficult period. So again it’s a it’s a very qualitative sort of trying to come to an understanding of what happened… and then make our best guess what we anticipate may happen next time.”
I made bold the parts I think are essential.
If you are like-minded and believe what we believe, contact us.
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