The weight of evidence is becoming increasingly bearish for the US stock market

 “The trend is your frienduntil the end when it bends.” 

Stock indexes making higher highs and higher lows is a good thing – until it isn’t.

I run a combination of systems. Most of them are trend following in nature, meaning the objective is to enter a trend early in its stage to capitalize on it until it changes.

But when trends reach an extreme it’s time to take note.

For me, what follows is what I consider market analysis, which doesn’t necessarily result in an specific trades, per se, but instead, it’s my intellectual exercise to understand what’s going on. And it’s nice to have an idea of when a trend may be ready to change.

In law, weight of evidence “refers to the measure of credible proof on one side of a dispute as compared with the credible proof on the other.

It is the probative evidence considered by a judge or jury during a trial.

In this case, the jury are active investors in the market.

Probative evidence is having the effect of proof, tending to prove, or actually proving. So, when a legal controversy goes to trial, the parties seek to prove their cases by the introduction of evidence. If so, the evidence is deemed probative.

Probative evidence establishes or contributes to proof.

The weight of evidence, then, is based on the believability or persuasiveness of evidence.

Since we never know the future in advance, when we engage in market analysis, we necessarily have to apply the weight of the evidence to establish the probability.

After monitoring price trends and a range of indicators intended to measure the strength of a trend for more than two decades, I’ve got a feel for the weight of the evidence. So, my confidence in these observations has increased over time, even as imperfect as it is.

Let’s see some evidence to weight.

By the first of June, 98% of the S&P 500 stocks were trending up, above their short term trend 50 day moving average. Since then, we’ve seen some divergence between the stocks in an uptrend and the stock index.

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It tells us fewer stocks are participating in the uptrend.

The advantage of monitoring breadth measures like % of stocks above a moving average or bullish percent is it’s a high level barometer that may highlight what is changing. Sometimes, it’s what is diverging.

In this case, the price trend of the stock index is diverging with the percent of stocks in a positive trend.

One of the warning signs in January and February was this same divergence between the uptrend in $SPY and the breadth of participation of the individual stocks in the index.

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When I see divergence, it reminds me to look inside to see what has changed.

It’s usually explained by sector rotation.

For example, over the past month, Technology and Communications have shown relative strength, but the momentum in Consumer Discretionary and Utilities are the laggards.

As a new trend gets underway, some of the component sectors within the S&P 500 diverge, so we also see it show up in the percent of stocks trending up vs. down.

After watching quantitive technical indicators like this since the 90s, I can also tell you we commonly see a breadth thrust in the early stages of a new uptrend. We did in January to February 2019 after the waterfall decline at the end of 2018.

A breadth thrust is bullish confirmation.

How long the trend may last, well, we’ve always preferred to see more stocks parts-cation in an uptrend than less. The theory is a broad uptrend that lifts all boats has more true momentum. An example of elevated breadth was 2017, when the stock index trended up with very little volatility or setbacks.

But if you look real close, that yellow highlight of 2017 also shows the percent of stocks above their 50 day moving average oscillated between the 50 and 95% zone throughout the year. It’s an oscillator, so it swings between 0% and 100%, but the fact it stayed above 50% in 2017 was a signal of internal strength. It often swings wider in a typical year, but 2017 was far from typical.

The bottom line is, what we have here, now, is fewer of the S&P 500 stocks trending up, which means more are crossing down below their intermediate trend trend line.

So, my interpretation is the trends are weakening, and it’s likely to be more reflected in the stock index eventually.

Investor sentiment is another essential measure.

Nothing drives investor sentiment like a price trend. As prices trend up, people get more bullish (or greedy) and as prices trend down, they feel more fear (of losing more money.)

The Fear & Greed Index tracks seven indicators of investor sentiment. It’s gradually dialing back up to Greed, but not yet Extreme Greed.

But when we take a look inside, and understand how it works, I see the main holdout is VIX . At around 22, the VIX still indicates a moderate level of FEAR, but we have to consider VIX is fading from its highest level, ever, so its absolute level may not be as indicative.

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On the other hand, the level of the Put/Call Ratio is among the lowest levels of put buying seen during the last two years, indicating EXTREME GREED on the part of investors.

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Junk Bond Demand has reached EXTREME GREED. Investors in junk bonds are accepting 2.05% in additional yield over safer investment grade bonds. This spread is much lower than what has been typical during the last two years and indicates that investors are pursuing higher risk strategies.

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The 3rd EXTREME GREED indicator is the S&P 500 is 15.28% above its 125-day average. This is further above the average than has been typical during the last two years and rapid increases like this often indicate extreme greed, according to the Fear & Greed Indicator.

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Aside from neutral $VIX, some other moderate hold outs of the 7 indicators include breadth. The Fear & Greed Indicator uses the McClellan Volume Summation Index, which measures advancing and declining volume on the NYSE. It has fallen from EXTREME GREED just over a week ago.

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Stock Price Strength is another moderate GREED level. It says the number of stocks hitting 52-week highs exceeds the number hitting lows and is at the upper end of its range, indicating greed.

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Safe Haven Demand is at a bullish investor sentiment level. Stocks have outperformed bonds by 6.87% during the last 20 trading days, close to the strongest performance for stocks/bonds in the past 2 years – investors are rotating into stocks from the relative safety of bonds.

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THE BOTTOM LINE IS: The seven indications of investor sentiment are dialing up to a very optimistic level, signaling investors are bullish on stocks.

Though some of it isn’t yet extreme, when we put it in context, anything can happen from here, but its now at a higher risk zone.

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Another measure of investor sentiment is put volume. Puts are listed options on stocks and indexes that may be used to hedge the downside. The CBOE Total Put Volume is at the lowest level this year, which suggests there isn’t a lot of hedging taking place.

The NAAIM Exposure Index represents the average exposure to US Equity markets reported by the members of the National Association of Active Investment Managers. They are fully invested for the first time since December. Their exposure to the stock market has followed the trend of the stock index.

Another sentiment poll is the Advisors Sentiment, which was devised by Abe Cohen of Chartcraft in 1963 and is still operated by Chartcraft, now under their brand name of Investors Intelligence. This survey has been widely adopted by the investment community as a contrarian indicator. They say since its inception in 1963, the indicator has a consistent record for predicting the major market turning points. It has reached that point.

Speaking of Abe Cohen, another indicator he developed in the mid 1950s is the Bullish Percent Index. He originally applied it to stocks listed on the NYSE, but we have been doing the same for other listed stocks and sectors since. The NYSE Bullish Percent is an example of another gauge of overall market risk. A common analogy applied to the NYSE Bullish Percent is that of a football game: level of the bullish % represents the current field position and the “end-zones” are above 70% and below 30%.

Currently, at 70%, it has entered the higher risk zone, suggesting it’s time to put the defensive team on the field.

Many of these indicators are measuring the same thing; investor sentiment.

After everyone has already gotten bullish and put their money to work in stocks, we have to wonder where future demand for shares will come from.

It’s been a nice run, but stars are aligning to look more and more bearish in my opinion. Uptrends are great, but all good things eventually come to an end.

If we want to protect our profits, it is probably time to reduce expose or hedge.

And that’s likely right about the time most people are excited about their stocks and wanting to buy more.

What could go wrong?

As of this writing, we have a CAT 4 hurricane just hours from hitting Texas and Louisiana, the Fed meeting tomorrow, and China firing missiles into disputed sea.

That’s the weight of the evidence as I see it.

You can be the judge if the evidence is believable and persuasiveness enough, but the final arbiter will be the price trend in the coming weeks.

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

A lot of talk about the NASDAQ being 21% above its 200 day moving average

There’s a lot of talk about the NASDAQ being 21% above its 200 day moving average, so… here’s my 2 cents on the matter.

Yes indeed, the NASDAQ is over 21% above its 200 day moving average. So, if the 200 SMA is your exit, you’d endure a 21% drawdown waiting to sell. I’ve got a ratio chart for it, too. The 1.216 = 21.6% variation. Also note, it’s higher than it was in February.

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At a ratio of 1.20 it was high in February, since 1.20 = the level of the NASDAQ was 20% higher than its own 200 day SMA. How high is that?

It’s a decade high!

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So, yeah, the NASDAQ seems stretched…

Like the CBOE Put/Call Ratio I shared in Here’s what the equity options put call ratio is telling us, and what it isn’t, the % above a moving average is another indication of sentiment.

When it’s as high as it is now, the market very enthusiastic.

For example, the Fear & Greed Index calls it market momentum and uses the 125 on the S&P 500 as a measure of investor sentiment.

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Chatting with some friends on Twitter, someone asked about the relative comparison to the 2000 stock market bubble.

The current period is no comparison to 1999-2000 when the NASDAQ was 50% above its 200 day SMA.

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Here is the ratio between the NASDAQ and its own 200-day moving average back to 1985. The relative ratio level the NASDAQ got in 1999 was the highest ever seen.

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Interestingly, I first started observing to get trading signals from relative strength ratio charts in the late 90s, and by the time 1999-2000 rolled around, I was comparing not only stocks to other stocks and their sector index, but also a cross section of global markets. For example, stocks vs. bonds, etc.

The NASDAQ was all the craze around 1999, and I had a t-shirt that said “NASDAQ; the world puts its stock in us.”

With technology leading with momentum, the tech heavy nas is seeing some popularity again.

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Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor 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.

Volatility, Put/Call Volume, and such

I see some hedging demand in the options market.

The ratio between Index puts and calls doesn’t get much higher than this. The CBOE Index Put/Call Ratio is elevated at 1.86, indicating probable hedging in the options market.

To be sure, here is the index put volume compared to index call volume.

Total options volume is relatively low for 2020, however.

But, right at its long term average.

The CBOE Equity Put/Call Ratio shows us the relative volume of individual stock puts and calls. Equity call volume was extremely high on June 8th, and has since mean reverted. I considered it to be very speculative, since call options are mostly traded for upside speculation in the underlying stock.

I pointed out before that speculative call volume reached an extreme high level, which was a contrary indicator.

Indeed, the S&P 500 index peaked with the peak in speculative call buying.

The decline in the S&P 500 so far has only been -7%, and it started June 8th. It remains about -6% from its high.

The options market doesn’t see a lot of hedging near the stock market peaks, but it sure does after the market trends down.

The S&P 500 tapped the 200 day moving average last week, but is trying to trend above it. Today was a good start, if it can hold the line.

For those who like the concept of mean reversion, here’s your sign.

This market has impressive resilience, but we never know the next -5% or larger down day is coming.

Well, I may not know for sure, but I know when the odds are stack in our favor as I showed in “If we’re going to see a second leg down, this is where I think it will start.”

For now, expected volatility contracted nearly -9% today, so the options market believes we’ll see less range over the next 30 days.

We’ll see…

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

Global Macro: Signs of bullish sentiment across the globe

In some cases, the recovery of economic and market trends are as impressive as the rate in which they fell.

The so-called “panic button” indicator, TED Spread, is back down to low levels. The chart tracks the daily TED Spread (3 Month LIBOR relative to the 3 Month Treasury Bill) as a measure of the perceived credit risk in the U.S. economy. It tends to widen during times of economic uncertainty. The TED Spread spiked up briefly in March, but has since settled back down.

The TED Spread spiked up briefly in March, but has since settled back down.

German economic sentiment snapped back fast.

The ZEW Indicator of Economic Sentiment is a leading indicator for the German economy. It reflects the expectations in six months of 300 financial experts on inflation rates, interest rates, stock markets, exchange rates, and oil prices for leading global economies. A value greater than 0 reflects more optimism than pessimism and a value less than 0 reflects more pessimism than optimism with respect to economic sentiment.

ZEW Indicator of Economic Sentiment for Germany is at a current level of 63.40, which is right at the high it reached in 2014.

ZEW Indicator of Economic Sentiment for Germany and the Eurozone updates will be released tomorrow, so we’ll see how they have trended through June.

US Consumer Sentiment has trended up off its low. We’ll see if it can continue this uptrend with the COVID cases trending up again.

The Sabrient Insider Sentiment Index is designed to identify companies with potentially superior risk-return profiles that also are;

(1) reflecting favorable corporate insider buying trends (determined via the public filings of such corporate insiders) and/or

(2) have recent earnings estimate increases published by Wall Street analysts.

The Sabrient Insider Sentiment Index declined with the stock indexes in March and has recovered in similar fashion. As with investor sentiment measures, it seems to follow price. Nothing drives sentiment like the price trend.

Speaking of sentiment, the Citigroup Panic/Euphoria model is a gauge of investor sentiment. It identifies “Panic” and “Euphoria” levels which are statistically driven buy and sell signals for the broader market.  Historically, a reading below panic supports a better than 95% likelihood that stock prices will be higher one year later, while euphoria levels generate a better than 80% probability of stock prices being lower one year later.

The current reading of the Citigroup Panic/Euphoria model at 0.41 indicates euphoria and anything at or below -0.17 indicates panic.

The S&P 500 EQUAL WEIGHT is probably the best measure of the U.S. stock market. Here, I charted both the standard capitalization weighted index along with its Equal Weight counterpart. The cap-weighted S&P 500 is heavily driven by its top holdings, whereas the equal-weighted index holds about .20% in the 500 or so stocks in the index.

The S&P 500 Equal Weight Index declined -40% in March, which is more than the -34% of the S&P 500 weighted based on company size. The equal-weighted index also remains in a -17% drawdown off its highs, which is more than the standard SPX index, which is more weighted to the largest stocks.

For example, below are the top 25 stocks in the cap weighted S&P 500 everyone follows. As these top stocks have as much weighting in the index as 5%, the equal weight only holds about 0.20% in these same stocks.

SymbolName% Weight
MSFTMicrosoft Corp5.94%
AAPLApple Inc5.81%
AMZNAmazon.com Inc4.51%
FBFacebook Inc A2.22%
GOOGLAlphabet Inc A1.69%
GOOGAlphabet Inc Class C1.65%
JNJJohnson & Johnson1.44%
BRK.BBerkshire Hathaway Inc Class B1.36%
VVisa Inc Class A1.28%
JPMJPMorgan Chase & Co1.17%
PGProcter & Gamble Co1.14%
UNHUnitedHealth Group Inc1.10%
HDThe Home Depot Inc1.03%
MAMastercard Inc A1.03%
INTCIntel Corp0.97%
NVDANVIDIA Corp0.91%
VZVerizon Communications Inc0.88%
TAT&T Inc0.83%
ADBEAdobe Inc0.82%
NFLXNetflix Inc0.80%
PYPLPayPal Holdings Inc0.79%
DISThe Walt Disney Co0.79%
MRKMerck & Co Inc0.76%
BACBank of America Corp0.75%
CSCOCisco Systems Inc0.75%
S&P 500 Holdings as of June 26, 2020

The price trend for Emerging Markets stocks has been dismal since the 2007 peak, which has had some negative impact on global macro. That is, considering the killer trend from 2003 to 2007 has a strong return driver for us, it hasn’t been the case since then. So, we’ve not had much exposure to EM, even though it’s now considered undervalued relative to the rest of the world, for me, it has to be trending up with some momentum. This tend is non-trending and volatile.

Zooming in to the year to date, at least the MSCI Emerging Markets Index only declined about the same as US stocks.

Looking inside the EM Index we see the top country exposures are China, Taiwan, South Korea, India, and Brazil, all of which we can gain portfolio exposure via ETFs.

Looking at these individual emerging countries, Brazil has been hammered the most, Taiwan, Korea, and China have been relatively resilient.

In fact, the trend in China is probably surprising to investors, especially considering it’s where the COVID-19 Coronavirus started. China only had a -18.4% drawdown priced in US Dollars.

Brazil has some of the worse COVID trends in the world right now, which isn’t helping their stock market trend either.

Here’s a view of the global stock market trends. Though they are down from their February 2020 highs, they are well above their March 2020 lows.

Gold has had one of the most asymmetric risk/reward profiles YTD. In 2020, Gold has only only down about -3% and a drawdown from its peak of -11%, but it has gained 16%. That’s relatively strong asymmetry.

Gold is no contest against the long term US Treasury Index in 2020. Long Term US Treasuries have the strongest momentum and asymmetric risk/reward year to date, which is why I have exposure. Gold has still been a good asymmetric risk/reward, though.

We remain on defense and invested in bonds for now as they seem to exhibit the most asymmetric risk reward.

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Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor 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.

So far, 2020 has shown us some fine examples of risk, investor sentiment, divergence, and volatility

Implied volatility, as measured by the CBOE Volatility Index (VIX) has trended up about 50% since the most recent low on June 5th. I’ll call it a moderate volatility expansion. Normally a volatility expansion from 23 to 40 would be considered a material event, but relative to the highest spike we’ve seen in March, it doesn’t seem huge for 2020.

The Bank of America Bull & Bear Indicator is at 0.90 vs. 0.40 last week. It is used as contrarian indicator to identify market extremes in investor sentiment. Currently, their measure of investor sentiment is very bearish, which is bullish for the stock market.

BofA Bull & Bear Indicator

Bank of America Private Client Sentiment shows bearishness, and here is a line chart showing its history.

BofA Private Client Sentiment

On the topic of investor sentiment, and the Bank of America Bull & Bear Indicator, here is a chart of its history going back to 2002. As marked on the chart, it was backtested pre-2013.

BofA Bull & Bear Indicator History

I share the CNN Fear & Greed Index a lot, because it’s easily assessable, so anyone can view it. The Fear & Greed Index is neutral right now.

Within the Fear & Greed Index are seven different investor sentiment indicators. Unlike the Bank of America Private Client Bull & Bear Indicator, which is a survey of their clients, the Fear & Greed Index is derived from quantitative technical indicators.

Stock price breadth, or how well stocks are participating in the uptrend, is the leading driver on the Greed side. They use the McClellan Volume Summation Index, which measures advancing and declining volume on the NYSE. It shows during the last month, approximately 8.08% more of each day’s volume has traded in advancing issues than in declining issues, pushing this indicator towards the upper end of its range for the last two years, which is extremely bullish.

The only other of the seven indicators showing bullish investor sentiment is safe haven demand. That is, the demand for bonds over stocks. They measure it by the difference between the past 20 day stock and bond returns. Stocks have outperformed bonds by 6.99% during the last 20 trading days. 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. Of course, this bullish investor sentiment is a sign that greed is driving the market. Notwithstanding these two extremes, overall, the Fear & Greed Index remains neutral.

Value is a Value

The dispersion of stock valuation multiples between the lowest and highest valuations has narrowed. But, despite the recent relative strength in value, it is still wide relative to history. So, value stocks remain a relative value.

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Hot Momentum Stocks are Showing Relative Strength

According to Goldman Sachs, the most popular retail trading stocks have materially outperformed the S&P 500, so far.

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Cross-Asset Realized Volatility has been Extreme

Another sign of dispersion is the number of 3 standard deviation prices moves. We’ve already seen more extreme trends across asset classes in 22 years.

Volatility and Number of 3-Sigma Moves

Despite the impressive V shaped rally from what is so far the low on March 23rd, I continue to notice the mean reversion year to date and over the past year. Here is year to date, and I marked the high, low, and average percentage.

At the low, the S&P 500 was down about -31% YTD. With the help of a very aggressive Federal Reserve proving liquidity, it has recovered most of the decline in one of the fastest in history.

It ain’t over till it’s over, and this ain’t over.

Asymmetry is about the upside vs. the downside in terms of asymmetric risk/reward. No observation of the price trend is complete without also noting the downside drawdown it took to achieve it. The drawdown for the S&P 500 was an astonishing -34% in just 23 days. It’s a reminder of risk.

I believe risk must be measured, directed, and controlled if we are to compound capital positively.

It doesn’t matter how much the return is if the downside risk is so high you tap out before it’s achieved.

Clearly, in 2020, we’ve surely seen some of the finest examples of risk, divergence, and volatility.

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Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor 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.

Individual investors are screaming bearish

The US Investor Sentiment survey shows individual investors are the most negative about the direction of the stock market they’ve been the past five years.

In fact, the last time investors were this bearish was over seven years ago, in January 2013.

I remember 2013 started off with great pessimism, but end up a stunner.

There was a lot going on in the news in 2012 going in to 2013, so investor sentiment reflected it. Then, there was the stock indexes finally reaching their late 2007 highs after a crushing -56% bear market. It took over five years to recover, but it finally did by the end of 2013.

This time may be different.

The individual investors survey for the sentiment gauge may be right.

But more often than not, when their sentiment reaches an extreme, the market proves them wrong.

Anything is possible. Every new trend is unique. The Fed and US Treasury have made it clear they’ll do anything necessary, so those of us moving around big money probably do so knowing the Fed Put is there.

The Fear & Greed Index is diverging from the sentiment poll. The Fear & Greed Index looks at seven different indicators to gauge investor sentiment. Only one of them is positive right now and the level is at mid field.

US Bullish investor sentiment is at an extreme level, too.

The Bull Bear Spread is about as low as it has ever been.

The market climbs a wall of worry, and that’s exactly what it’s been doing.

So far.

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Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor 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’s not so different this time, except in ’69, they didn’t miss the Woodstock Music Festival

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.

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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 TacticalMike 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.

Here is how you will get exactly what you want

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:

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.

Common Causes of Cognitive Bias

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.

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Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor 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.

Volatility contraction, sentiment shifts, and most are participating in the uptrend

On February 6th, I shared and observation in “19 is the new 20, but is this a new low volatility regime?” the lower level of implied (expected) volatility at the time may be driven by two factors that may have been resulting in less concern for volatility. I wrote:

The current bull market that started in March 2009 is the longest bull market in history. It exceeded the bull market of the 1990s that lasted 113 months in terms of time, though still not as much gain as the 90s.

The U.S. is in its longest economic expansion in history, breaking the record of 120 months of economic growth from March 1991 to March 2001, according to the National Bureau of Economic Research. However, this record-setting run observed GDP growth far slower than previous expansions.

The aged bull market and economic expansion can naturally lead to some level of complacency and expectation for less downside and tighter price trends. When investors are uncertain, their indecision shows up in a wide range of prices. When investors are smugger and confident, they are less indecisive and it’s usually after a smooth uptrend they expect to continue.

Well, so much for that.

Here we are, the bull market was interrupted by a -37% in the Dow Jones. So, any higher highs from here will be labeled a new bull market.

The US is now in a recession. The longest economic expansion is over, interrupted by a -4.8% GDP, as discussed in “The longest economic expansion in U.S. history is over, but…

What about volatlity?

I shared several observations of volatility and

Back in December, I wrote “A volatility expansion seems imminent” which was a follow up to November 16th, “Periods of low volatility are often followed by volatility expansions”.

Don’t say I didn’t tell so, in advance.

I also wrote:

Is the volatility expansion over? in December.

On January 27th, published “Here comes the volatility expansion, but is the coronavirus outbreak in China to blame?

January 30th “Global Macro: is the coronavirus outbreak crushing the China ETF and causing the volatility expansion?

February 26th was “What volatility expansions tell us about expectations for stock market trends”

March 3rd was pretty clear “Expect wider price swings in a volatility expansion

Then, on March 10th I wrote again about the volatility expansion “
Why I’m not surprised to see such a volatility expansion

This chart was featured in the Wall Street Journal by one of the few outside research I read; The Daily Shot.

Average True Range ATR use in portfolio management trading volatlity

Oh yes, did that chart reverse trend as expected.

Now there’s this. The CBOE Volatility Index (VIX) spiked to 82, the highest level of implied vol on record.

But since then, it is gradually trending down.

The options market is pricing in less expected volatility for the S&P 500 stocks over the next 30 days.

It’s a volatility contraction.

Will it continue?

It will as long as expected vol keeps declining. I know; captain obvious.

VIX is trending down, but it’s still at 31, and still a wider than average range of prices spreading out.

If we see a reversal down in stocks, then we’ll see volatility spike again. But for now, it’s a volatility contraction, so I’ll take it.

The Fear & Greed Index is only dialed half way up.

Only two of the Fear & Greed Index indicators are showing greed. Safe haven demand is the biggest, which is the difference between the 20-day stock and bond returns. Stocks have outperformed bonds by 16.29% the last 20 trading days. This is close to the strongest performance for stocks relative to bonds in the past two years and suggests investors are rotating into stocks from the relative safety of bonds.

The other is the Put/Call Ratio. During the last five trading days, volume in put options has lagged volume in call options by 44.87% as investors make bullish bets in their portfolios. However, this among the lowest levels of put buying seen during the last two years, indicating greed on the part of investors.

By my measures, the stock market is just now entering the overbought range, technically, on a short term basis.

For example, the percent of S&P 500 stocks above their 50 day moving average is now up to 74% after todays close. It’s the higher risk zone.

As a testiment to the internal damage done, I present the percent of S&P 500 stocks above their 200 day moving average, which is only at 30%. It tells us most stocks are still in a longer term downtrend after reaching a low of only 3% of stocks above their trend line on March 20th.

And yes, it was very near the March 23rd low only three days later.

Most stocks are participating in the uptrend, as measured by 70% of them above their average of the past 50 days.

Volatiltiy is contracting.

Investor sentiment is gradually shifting. Nothing drives sentiment like the price trend. The price trend is the leading indicator, investors enthusiasm follows it.

All while we just saw the largest drop in economic growth since 2008.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor 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.

Most people get it wrong at extremes

Irving Fisher was probably considered, by some, to be one of the smarter people of his time. Fisher was an American economist, statistician, inventor, and Progressive social campaigner. 

But, even with all his schooling at the turn of the century, he was just as silly as everyone else. In 1929, just before the -86% crash, he said:

“Stock prices have reached what looks like a permanently high plateau.”

– Professor Irving Fisher, October 15, 1929

At the time, US equity valuations had never been higher.

The moral of the story is; if you don’t have your mind right, you’re probably wrong.

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

You probably want to sell stocks, now

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

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

On January 11, I wrote:

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

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

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

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

fear greed index

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

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

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

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

stocks stock market at all time high

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

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

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

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

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

What has changed?

A lot has changed since then.

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

The speed of the decline was most impressive.

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

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

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

 ― Warren Buffett

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

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

That’s what I’ve been doing.

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

It all seems so uncertain, but it always is.

“Don’t fight the Fed.”

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

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

RISK MANAGER / RISK TAKER

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

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

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

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

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

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

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

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

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

What would it take?

I have no idea.

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

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

It’s what I call ASYMMETRY®.

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

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

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

Self-discipline, Panic Selling, and the Cycle of Emotions

At the moment, the popular US stock market indexes are down over 25% from their years year-to-date.

STOCK MARKET CRASH 2020

Looking at the Cycle of Market Emotions, where do you think we are at this moment?

THE CYCLE OF MARKET EMOTIONS

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.

stock maket crash volatility

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.

THE CYCLE OF MARKET EMOTIONS

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

 

 

 

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

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

Top news headlines looked like this:

fed rate cut march 2020

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

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

stock market feared bernie sanders fear the bern

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

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

Feeling the Bern of socialism may have been even scarier. 

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

 

Permabear delight

I love music, so it plays in the background in my office, instead of financial news. Sure, I have Bloomberg playing on a TV, but with the volume down. I rarely turn it up, unless someone I know is speaking of something I’m interested in. My day is filled with music, a wide range of music, so when I thought “delight” and typed out “permabear delight,” I heard three different songs.

A permabear is an investment manager or investor who is always negative about the future direction of the markets and the economy in general, no matter what. The parts of the word help us understand its meaning: “Perma,” which means permanent and “bear,” which is someone who believes the market will fall (a “bear” market.) 

I’ve never been called a permabear in my 20+ year investment management career. But recently, a new follower asked if I am a permabear. It’s understandable because all he’d read was the past few months of my observations, and I have indeed been increasingly bearish. I got utterly bearish late January as my tactical trading signals, risk management, and drawdown control systems guided me to remove our stock market exposure to zero. The signals from my signals drive any “feeling” of bearishness I may have. Additional factors are extreme investor bullishness, implied volatility at extremes, and people wanting to get more aggressive. This is the part I often share here, hoping to help people observe how they feel the wrong feeling at the wrong time, and by doing so, they may eventually learn to feel the right feeling at the right time.

I tend to feel the right feeling at the right time. It’s something I’ve intentionally worked on, daily, for over two decades now, and with repetition comes increased skill and experience. For long term readers of my observations, I hope you’ve observed that. For our investment management clients, they’ve seen it in action in real-time. So, I become increasingly bearish as my quantitative systems signal risk levels are elevated. But, I also become bullish when the algorithms signal a price trend and volatility may have moved too far, too fast. When price trends move too far, too fast, I consider it an overreaction to information. I’ve discussed it a few times lately, especially regarding the coronavirus outbreak. I believe we witnessed an initial underreaction to how investors may eventually react, and then what appears to be an overreaction. At least in the short term.

So, now, I’m far from a permabear myself. I have investment manager friends who are permabears, and their performance reflects it. I also have friends who are permabears and have been unable to invest their money outside an FDIC insured bank account. That has been a big risk to them over the decades, but they may not know it, but to each their own. Banks need CD savers so they can lend the money out to borrowers at higher rates. It all seems to work out as everyone gets what they want.

At this point, the widely followed stock indexes have declined sharply with speed. The S&P 500 is down -14% from its recent all-time high, and the Dow is down over -15%.  The chart below is the % off high to put these drawdowns into context. It still isn’t as deep as late 2018, but it is now very close and happened much faster.

stock market drawdown 2020

While this may be a buying opportunity for those of us who had cash to increase exposure at these lower prices, it’s always possible it could trend lower. What seems more likely at this point is prices get low enough to attract buying enthusiasm, and if it’s enough, it reverses this waterfall decline, at least temporarily. After that, this may well be the bigging of the next big bear market. It’s a process, not an event, although this decline does look much more like an event than usual since it was so far, so fast.

I’ve now become short term bullish on the stock market. My systems which have been quantified and scientifically tested for robustness are now signaling prices are now at a level we consider oversold and a countertrend back up, at least retracing some of the recent waterfall declines that appear to be an overreaction. For example, below is the current chart of the S&P 500, which is down another -3% today. Below the price trend is a  simple 14-day measure of relative strength, a momentum indicator measuring the magnitude of recent price changes to evaluate overbought or oversold conditions. Today it has reached 20, which is the point I consider oversold. In fact, it’s now as low as it was during the late 2018 -19% waterfall decline.

stock market crash februrary 2020

Of course, after prices fall, so does investor enthusiasm to invest in stocks. It is no surprise to see the Fear & Greed Index made up of seven different sentiment measures reach the “Extreme Fear” level.

cnn fear greed Warren Buffett said when it comes to investing in stocks, it is smart to be “Fearful when others are greedy and greedy when others are fearful.” Although I do a lot more tactical strategies that he does, at these extremes we have something in common.

We don’t invest our grocery money in stocks, but this may eventually prove to be a positive asymmetric risk-reward opportunity when risk is defined with a predetermined exit (stop loss) or positions structured in a way that define or limit downside risk.

A permabear, on the other hand, are maybe singing “Don’t go chasing waterfalls” by TLC, I’m hearing a diversified genre of some Rapper’s Delight by The Sugar Hill Gang, Afternoon Delight by Starland Vocal Band, and Dixieland Delight by Alabama if you want to follow along.

I’m about to take the longest trip to Florida to Tennessee of my life. I hope you have a great weekend. As always, next week will be fascinating. Investors will either fear losing more money or fear missing out if they tapped out at low prices. I have bypassed both in our managed portfolios as we avoided the waterfall decline, so we’re in a position of strength to increase exposure to risk and reward. If you sell higher, you can buy lower. At this point, we can tolerate some downside from any new exposure from here as we know its mathematically becoming less likely, and we are now positioned to not have any fear of missing out if the trend reverses up.

I hope this helps!

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

 

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

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

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

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

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

Investor Sentiment less bearish

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

bearish extreme sentiment

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

bearish investor sentiment signal

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

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

stock market drawdowns bearish sentiment

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

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

What about Bullish investor sentiment? 

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

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

bullish investor sentiment 2020

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

cnn fear greed index predictive

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

coronavirus headlines

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

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

John Maynard Keynes

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

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

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

Have a Happy Valentines Day and weekend, friends!

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

 

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

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

What we believe is always true, for us.

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

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

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

But, everything is relative.

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

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

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

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

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

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

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

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

consumer sentiment michigan

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

consumer sentiment recessions

Does consumer spending match consumer sentiment?

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

consumer spending sentiment retail sales global macro trend

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

US UNEMPLOYMENT RATE

What about the savings rate?

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

savings rate consumer sentiment

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

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

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

gas price past 10 years

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

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

gas price trend long term trend following

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

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

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

gas price consumer sentiment negative correlation

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

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

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

consumer debt as percent of disposable income

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

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

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

Investor sentiment shifts

We’ve seen a notable shift in investor sentiment.

AAII Sentiment Survey:

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

aaii investor sentiment

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

investor sentiment before coronavirus

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

bull bear spread chart aaii sentiment

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

fear greed index analysis backtesting investor sentiment

One of the seven indicators is Safe Haven Demand.

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

safe haven demand

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

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

bearish sentiment

We’ll see how it goes from here.

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

Investor sentiment is dialed up with stock trends

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

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

trend following breaktout uptrend 2017 crash 2018 asymmetic returns risk reward

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

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

Back to investor sentiment…

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

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

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

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

Fear and Greed Index

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

Fear and Greed over time

Who remembers how that turned out?

2018 Drawdown in stocks loss

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

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

So, individual investors are bullish, according to AAII.

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

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

S&P 500 market capitalization cap history

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

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

 



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

You probably want to invest in stocks

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

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

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

fear greed index

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

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

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

options speculation index

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

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

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

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

stocks stock market at all time high

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

aaii investor sentiment

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

US Investor Sentiment, % BEARISH

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

US Investor Sentiment % Bullish

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

 

investor sentiment for trading

AAII guesses:

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

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

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

Individual investors have a lot of opinions based on news:

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

Here is a sampling of the responses:

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

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

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

“Earnings versus forecasts.”

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

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

Is the AAII Sentiment Survey a Contrarian Indicator?

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

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

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

It goes on to add:

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

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

Two important conclusions:

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

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

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

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

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

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

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

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

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



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

What I’m reading into the new year

“Those who forget the past are doomed to repeat it”

One of the advantages of writing observations in real-time is the ability to go back and read them with perfect hindsight.

We know that global asset allocations of varying mixes of stocks and bonds have had a strong year in 2019.

global tactical asset allocation performance 2019 asymmetric return

Most of the gains were achieved in the first four months. Here are the return streams through May 1, 2019, for different targeted allocations.

Since May 1st, global asset allocation portfolios experienced much more volatility and less capital gain.

How did such a great year for stocks and bonds begin?

At the end of a year like this, I like to reflect on this time a year ago, especially since the market state is so radically different between now and then.

If we want to learn from the past and our experiences, it’s essential to revisit things from time to time.

A year ago, we celebrated Christmas with a stunning waterfall decline in stocks.

Today, we’ve enjoyed an equally stunning guiser in gains.

So, what has changed?

To gain an understanding, here is what I’m reading into the new year.

December 17, 2019:

What’s going to happen next for the stock market?

December 20, 2019:

The stock market has reached a short-term extreme as investor sentiment indicates fear

December 23, 2019:

An exhaustive analysis of the U.S. stock market

December 24, 2019:

An exhaustive stock market analysis… continued

January 1, 2019:

Investor Sentiment into the New Year 2019

If you read all of them, you’ll be surprised how much you learn about market trends,  behavior, volatility, and internals.

MERRY CHRISTMAS!

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.

 

 

 

 

 

After a strong year like 2019, investors should prepare for what could be the opposite in 2020 and it doesn’t seem they are

After nearly a -20% waterfall decline last October through December, in “An exhaustive analysis of the U.S. stock market” a year ago today I wrote:

“Someday in the future, stock investors will be giddy again and completely forget about how they feel right now.”

Sure enough, that’s what happened. Individual investors as gauged by the AAII Investor Sentiment Survey capitulated a year ago and have since then oscillated their enthusiasm for stocks sharply as a result of the stock price action. In the chart below we see the stock index with the bullish investor sentiment below it. Investor sentiment clearly oscillates up and down as investors swing from fear and greed, but right now they are bullish.

I also note the bullish sentiment evaporated during every market dip this year. The stock market has memory because its investors do so after such a fall a year ago investors were quick to react (emotionally at least) to every sign of another drop.

It looks like we’re ringing in the new year with high optimism in the stock market.

The Fear & Greed Index, which includes seven different investor sentiment indicators, is dialed up to the “Extreme Greed” level again as people are probably hopeful recent gainst will continue.

CNN FEAR GREED INDEX TRADING ASYMMETRIC

The last time this fear and greed gauge was this high was the end of 2017.

CNN FEAR GREED INDEX HISTORY BACKTESTED

The stock market has gained even more in 2019 than it did in 2017, but this year follows a waterfall decline.

After a strong year like 2019, I suggest investors prepare for what could be the opposite in the period ahead.

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

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

Keeping the mind right with investor sentiment indicators

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

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

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

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

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

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

As Walter Deemer says:

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

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

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

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

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

AAII allocation survey bullish

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

neutral investor sentiment at uppper end of range AAII

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

fear and greed index

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

fear and greed index over time

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

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

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

What really drives stock prices down?

What really drives stock prices? The price of stocks, just like groceries, is driven by supply and demand of people “the market” buying and selling. What drives stock prices and the stock market really is no more complicated than that.

Unless you make it more complicated, then it is for you.

What drives stock prices? It is probably one of the most asked questions we get.  It’s also one of the best questions, so I’ll share my observation of it as succinct as I can.

Many investors seem to believe stock prices, and therefore, the stock market is driven by the news of the day because they see the headlines. The press tries to construct a story of the cause and effect. But, if we look at the news headlines on any day, we observe vastly conflicting narratives and reasons for a stock market directional move. 

To be sure, here are the headlines I found online today. According to headlines, recent price action and volatility are driven by everything from Trump’s talk on a China trade deal to an overvalued stock market to factory data to the fear of missing out.

what drives stock prices

The answer is, “all of the above” drives the stock market.

The news is newly received or noteworthy information, especially about recent or relevant events. However, none of us can say which specific news actually drives stock prices. 

If you really want to know what drives stock prices, it’s just the market, doing what it does.

All information and news have the potential to drive stock prices, as does investor sentiment. The price of stocks, just like groceries, is driven by supply and demand of people buying and selling. When emotion gets imbalanced, prices trend. Yes, there’s another asymmetry!

When supply and demand are symmetrical, the price stays the same.

When supply and demand are asymmetrical, the price trends in the direction of the most pressure and enthusiasm.

After yesterday’s close, I saw someone ask, “Why did the stock market do so bad today?”

I’m guessing he saw a headline like this:

what drives the stock market causes stocks to go up and down

However, a Dow decline of -0.96% isn’t a significant drop, but if you anchor to the “-268 point drop” as most do, it may sound worse, to you.

I focus on the % change to normalize the movement. Normalizing with the percent change adjusts the values measured on different scales to a notionally standard scale. For example, the “-268 point drop” is one thing from an absolute level of 27,783, but a very different situation when the Dow was at 10,000. At today’s level of 27,783, it’s only -0.96%, but the same point drop when the index was 10,000 is -2.68%, nearly three times the single-day loss.

A -1% single-day decline in the stock index isn’t a lot by historical standards. If it feels like it is, the investor should either better inform themselves of market history or have little to no exposure to the stock market. I’ll help with the former below.

First, here are the stats. I’ll continue to use the Dow Jones Industrial Average index data.

So far, in 2019, the Dow has declined -1% or more on 18 days. When it declined -1% or more in a single day, the average drop that day was -1.7%. So, a -1% drop isn’t uncommon. It’s well within a normal range for a down day. I count about 231 trading days so far in 2019, excluding holidays, so 18 of those days falling -1% or more is nearly 10% of the days. And remember, the average drop those days was -1.7%, yesterday was only -1%.

Oh, and the worst day so far in 2019 was -3%, so it could be three times worse!

When we extend the lookback period to this time last year, the Dow declined -1% or more on 26 days. When it declined -1% or more in a single day, the average drop that day was -1.87%. Again, a -1% drop isn’t uncommon. Last December was a very volatile month.

2018 was more volatile than 2019, so far. In 2018, the Dow declined more than -1% on 35 days, and when it did, the average drop was -2%, and the worst day was -4.6%.

Investors tend to anchor to the recent past and extrapolate it into the future. That is, humans tend to expect what is happening now to continue. After a volatile 2018, most investors probably expected a volatile 2019. For many, the down days and downtrends in 2018 were a shocker after an abnormally quiet 2017. In 2017, the stock market trended up with little downside. We only saw 4 down days of -1% or more, and the average down day was only 1.3%, and the worse was 1.7%. You can probably see how many were stunned last year.

This may make you wonder when investor fear drives down stock prices, what is a “normal” down day?

It depends on the time frame and the market state over that time frame. Over the past three years, the Dow declined 57 days more than -1%, and the average down day was -1.9%, and the worst was -4.6%. That’s nearly 700 data points, so the sample size is likely enough to say we should expect a -2% down day is going to happen, and a -5% is possible.

To expand the sample size, I wondered how many -1% or more down days I’ve dealt with since I started managing our primary portfolio in May 2005. In the last fourteen years, the Dow has dropped -1% or more 427 days, and an average decline was -1.8%, and the worst down day was -9.4%! You can probably see why a -1% down day from my perspective isn’t a big deal, and the statistics of the data also confirms it’s well within a typical down day.

Of course, the trouble is larger downtrends being with down days. So, the investor’s concern isn’t just a single down day, but instead a series of down days, which is a downtrend. Before moving on to what drives stock prices and the stock market, let’s look at the downtrends.

Over the past year, the Dow Jones has declined more than -5% twice and -20% once starting last December. All of these downtrends include -1% down days. So, I’m not saying they don’t matter, but instead, the single -1% down day isn’t by itself significant.

Expanding the lookback period to the past 10 years, we see many downtrends of -5% or more. But, within those downtrends, there was only one -5.4% down day, but 245 down days over -1% with an average loss of -1.6%. Downtrends include these down days.

Next, we look all the way back to the beginning of the index data to observe its historical downside. The 1926 era Great Depression was by far the worst when the Dow Jones Industrial Average fell over -75%. It makes the 2007-09 period when it fell -50% look tame.

Clearly, if you invest in the stock market, you should expect to experience drops of -5% a few times a year, and -10% maybe once a year, and -20% or more at least every market cycle. If all you do is buy and hold stocks or stock funds, expect to experience a -50% because if history is a guide, it has happened before, so it could happen again.

You can probably see Why we row, not sail.

To understand what drives stock prices and how much of a loss is considered a large loss, we have to know the history. I hope I’ve shared it in a helpful way.

If there’s anything I hope individual investors get from my observations, it’s a better understanding of the risks of investing. The rewards of investing are well advertised, but the risks are what matters the most when our focus is asymmetric risk/reward. When prices of positions are trending in our favor increasing our investment account value, our concern isn’t that we are making too much money. Our interest is not giving up all the profit, which is a risk management function.

The exit, not the entry, always determines the outcome.

If you want to know what really caused the decline, I shared my opinion in a single chart that I believe sums it up best. It was good enough to make it in The Daily Shot in the Wall Street Journal. As the stock index has trended up quietly in recent weeks, volatility had contracted, as seen in the chart. As I shared, “Periods of low volatility are often followed by volatility expansions.”

Mike Shell Wall Street Journal WSJ

A few weeks ago, I also observed investor sentiment had reached an extremely optimistic level as stated in Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback.

Now that stock prices have fallen two days in a row, we’ll start to see the pendulum swing from extreme greed to a middle ground. If the stock market drops a lot more, investor sentiment will become fearful, just in time for a reversal back up again.

Some favor stories, others favor data and charts, I’m a math guy, so I prefer the data and visually seeing it in charts. I’m lucky to be able to write.

What we have here isn’t a failure to communicate, the news is everywhere. I think it’s a misunderstanding of what really drives stock prices down. It’s the desire and enthusiasm to sell.

Stock price trends, just like groceries, are driven by supply and demand of people buying and selling. When sentiment gets imbalanced, prices trend in the direction that has the most force and momentum.

Yes, it’s another asymmetry! Without the asymmetry, prices would stay the same.

In the spirit of ASYMMETRY® and asymmetric risk-reward payoffs, I’m naturally trying to get the most reward from my observations by helping as many people as possible, so share it! And enter your email on the right to get immediate notices of new ASYMMETRY® Observations. We do not sell or use your email address in any other way. Also, follow me on Twitter: @MikeWShell

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.

A volatility expansion seems imminent

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

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

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

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

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

Mike Shell Wall Street Journal WSJ

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

volatllity expansion vix asymmetric december 2019

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

Prepare yourself accordingly.

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

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

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

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

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

Why?

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

What about consumer sentiment?

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

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

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

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

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

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

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

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

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

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

consumer sentiment correlation with the stock market intermarket analysis

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

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

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

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

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

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

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

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

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

Someone asked:

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

Another commented:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Those who forget the past are doomed to repeat it. 

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

Have a great weekend!

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

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

Investor optimism is reaching extremes

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

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

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

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

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

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

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

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

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

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

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

AAII Investor Sentiment Survey

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

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

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

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

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

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

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

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

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

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

I focus on these extremes in investor sentiment.

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

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

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

Investor sentiment signals greed is driving stocks as the U.S. stock market reaches short term risk of a pullback

The Fear & Greed Index reaches the Extreme Greed level as I got a short term countertrend sell or hedge signal for U.S. stocks.

Investors are driven by two emotions: fear and greed.

Too much fear can drive stocks well below where they should be, an overreaction to the downside.

When investors get greedy, their enthusiasm to buy may drive stock prices up too far, an overreaction to the upside.

The Fear & Greed Index is a simple gauge that attempts to signal which emotion is driving the stock market. It’s made up of seven indicators, and though it doesn’t generate a perfect timing signal, it’s useful for investors to compare to their own sentiment.

fear greed index investor sentiment

As I pointed out last week, expected volatility has also declined to a low level. The VIX is now in the 12 range.

Here is a chart of the Fear & Greed index over time. As we highlighted, it’s at its historical peak.

fear greed index over time

Investors tend to want to do the wrong thing at the wrong time, so measuring extremes in overall investor sentiment is a useful way to modify investor behavior.

I operate with a massive intention of feeling the right feelings at the right time. Some claim to use systems to overcome their feelings or remove feelings altogether, but as a tactical decision-maker, I know it isn’t actually possible. I prefer to experence my emotions and let them be but have shifted my mindset to feel the right feeling at the right time.

Based on my systems and indicators, suggesting sentiment and price trends have reached a point of extreme, I feel more defense right now. My quantitative methods drive my feelings. I see the signal, get a good sense about it, then pull the trigger.

As sentiment is reaching the extreme greed level, as see the S&P 500 index below is at all-time new highs.

When I see such enthusiasm, it’s initially good for momentum, but it eventually fades and so does the price trend.

But, it doesn’t matter if we monitor quantitative measures without them driving our decisions. When I see points like this, it’s just a reminder to review my portfolio to see if I’m comfortable with the risk/reward exposures. If I see asymmetric risk/reward, I do nothing. If I have too much risk exposure, I reduce it or hedge it off.

We shouldn’t be surprised to see a decline of 2-5% from here or at least a pause, but anything is possible.

Being prepared in advance is a useful way to avoid bad investor behavior, which is why I predefined my exposure to the possibility of loss by knowing in advance when I’ll exit or reduce the exposure.

 

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.

What I learned about Semper Fi from former Tennessee Coach Phillip Fulmer

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.

Mike Shell Capital Neyland Stadiium Statue

On the wall behind the statue are the names of the proud donors, myself included.

Mike Shell Capital Neyland Tennessee Volunteers Vols Knoxville

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.

Investor fear has been driving the stock market down

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.

investor sentiment extreme trading

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.

fear greed index

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.

advisor money manager using fear greed index extreme behavior

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.

“THEY KNOW NOTHING!”

Today marks the 12 year anniversary of the Jim Cramer character on CBNC having his now-famous emotional breakdown on live TV. It’s worth listening to once a year to reflect on the extreme level of panic going on this day 12 years ago.

So, I have shared it below.

I was cool as a fan that day… my risk management methods were robust and I had developed the discipline to execute through it. Avoiding the waterfall declines and panic level losses has been the highlight of my experience so far.

I believe we’ll see another period like this and the next time, it could even be worse.

I also managed through the 2000-03 period well, too, by simply observing bonds were trending up as stocks were trending down, so I shifted from stocks to bonds.

As such, I’m prepared and as ready as I’ve ever been, and hopefully, my past experience of operating through the last two major bear markets will continue to compound my skill and discipline.

 

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.

Now we’re seeing some volatility expansion

I suggested in Is volatility setting up for an expansion? we may see volatility increase.

Sure enough, implied volatility, as measured by the VIX, has trended up from 12.16 to 15.30, which implies the expected volatility over the next 30 days has examined from about 12% to 15%.

VIX

The bands around the price trend below use a measure of realized historical volatility (standard deviation) over the past 20 days. As the realized volatility has contracted, it signals the range of prices spreading out has been narrow. This is an uptrending, quiet, market condition. When I see one market condition like this I’m alert for it changing.

bollinger band spx

In the next chart, we observe another channel of volatility around the stock index measured with average true range (ATR) and it has been a tighter band. The stock index price has also been pushing the upper boundary since the beginning of the year.

spx atr channel position sizing

Periods of low and contracting volatility are often followed by periods of higher and expanding volatility.

On the other hand, here we see the realized volaltity of implied volatility has reached its upper band, so if it remains within a normal range, it may remain inside the band. However, it can certainly spike up if the market expects higher movement.

vix volatilty of volatlity

So, Semper Gumby, always flexible.

This uptrend could change.

I know when I’ll exit all my positions if they trend down enough to cut my losses short. I also know what percent of drawdown that would lead to if all of my positions decline together. If I wanted, I could tighten it up to reduce the drawdown if prices fall more. Or, I could hedge with a short index position or go long volatility.

You can probably see how everyone decides what they get from the market.

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.

Feeling and Doing the Right Thing at the Right Time

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

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

vix volatility expansion regime change

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

I believe the timing is everything.

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

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

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

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

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

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

equity put call ratio asymmetric risk reward

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

cboe index put:call ratio aymmetric risk reward

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

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

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

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

Stock Market Update

After gaining over 6% since the low on Christmas Eve, the S&P 500 declined -2.45% today. We can expect a wider range of prices in a volatility expansion after a -20% decline.

spx january 3 2019

I say it’s a volatility expansion because implied volatility is relatively elevated at 25.45, implying a 25% range of prices is implied by options prices on the S&P 500 stocks.

vix volatility expansion

Looking over its full history, we’ve seen the VIX trend higher, but it’s relatively elevated. Its long-term average is about 20. But, for mean reversing indicators like the VIX, the average doesn’t mean much since it doesn’t stay there.

vix long term history

Another way I define a volatility expansion is realized volatility. The VIX is expected volatility implied by options prices, realized volatility is actual historical volatility. In the chart below I added an average true range over the past 14 days above the S&P 500 stock index price trend. We can see how volatility expanded as the price trend fell. Prices tend to spread out in a wider range in a downtrend. We can see this in the chart. There was a regime change from a low volatility uptrend to a downtrend with volatility expansion.

atr volatilty expansion realized vol asymmetric risk reward

The CBOE Put Call Ratios spiked up today. Zooming in to a 30 day period, we see the Index Put Call Ratio is about where it was at the lows in December. I believe the Index Put Call Ratio is a better indication of extremes in fear of lower prices because index options are mostly traded by professionals and used for hedging. The Equity Put Call Ratio is options on individual stocks and more non-professionals and tends to be more speculative. I explained it in Investor Sentiment into the New Year 2019. 

put call ratio january 2019

To get a longer view below is the past five years of the Put Call Ratios. They’ve been higher in 2015, but are clearly at elevated levels. It indicates the put volume on index options is 155% more than call volume, which suggests hedging or speculative bets the index will decline.

put call ratio peaks past years 2018

Prices decline until the selling pressure is exhausted. Selling pressure is exhausted after those who want to sell have sold, which pushes prices down to a low enough point to attract buyers. To get an indication of when prices have trended down far enough to exhaust sellers and attract buyers, I look at the price trend itself as well as extremes investor sentiment and breadth. Below is the percent of stocks in the S&P 500 below their 200 day moving average. The percent of stocks above their 200 day moving average reversed back down… only 14% are in a positive uptrend. There are currently 505 stocks in the S&P 500. Of the 18 that are above their 50 day moving average, two are because they are being bought out Celgene CELG and Redhat RHT. Some of the others are kind of recession stocks like auto parts, discount store, and a gold stock: AZO ORLY DLTR NEM.

percent of stocks above 200 day moving average $spx $spy spx

The percent of S&P 500 stocks above their 50 day moving average reverses back down… only 3% are in an uptrend…

percent of stocks above 50 day how to use it spx

The stock market is approaching oversold levels again but may get more oversold before reversing back up.

One advantage of falling stock prices is as price falls, the dividend yield rises from that new price. This is not a recommendation to buy or sell any security, but below is the price trend and dividend yield the Global X SuperDividend® ETF (SDIV). It invests in 100 of the highest dividend yielding equity securities in the world. We can observe as the price trends down, the dividend yield trends up. That is, if we buy high yielding assets at lower prices, the dividend payment is higher from that starting point assuming the companies keep paying their dividends. Below we can see how this ETF yield has increased to 9% as its price has fallen -35% off its high.

high yield income strategy sdiv dividend etfLike any investment, it isn’t risk-free. Investing always involves risk, including the possible loss of principal. High yielding stocks are often speculative, high-risk investments. These companies can be paying out more than they can support and may reduce their dividends or stop paying dividends at any time, which could have a material adverse effect on the stock price of these companies and the Fund’s performance. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. The bottom line is; there is no free lunch. If we want the potential for return, we have to take risks.

If this is the early stage of a larger decline, it will unfold with many up and down swings along the way. It will get overbought/oversold over and over and sometimes stay that way longer. I shared it in An exhaustive stock market analysis… continued. 

Emotional undisciplined investors, traders, and portfolios managers will be destroyed in a volatility expansion. They’ll swing from the fear of missing out to the fear of losing money as the stock market swings up and down.

Self-discipline and emotional fortitude are essential to be an investment manager.

We’ll see how it all unfolds from here.

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 into the New Year 2019

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.

Bearish Investor Sentiment is Negatively Correlated with Stock Index Returns

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.

Bullish Investor Sentiment is Positively Correlated with Stock Index Returns

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.

VIX VXX VXXB 2018 VOLATILITY EXPANSION TRADING INVESTMENT ADVISOR.jpg

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.

equity put call ratio 2018 spx spy

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.

INDEX PUT CALL RATIO CBOE 2018

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.

total put call ratio spx comparison

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.

spy spx stock index 2018 bear market

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.

An exhaustive stock market analysis… continued

I guess An exhaustive analysis of the U.S. stock market wasn’t exhaustive enough, because I now have a few things to add.

First, since the financial news media, as well as social media like Twitter, is so bearish with all kinds of narratives about why the stock market is falling, I’ll go ahead and discuss it here. This observation will not be complete without first reading An exhaustive analysis of the U.S. stock market so you know where I am coming from. If you haven’t read it already, I would before continuing so you understand the full context.

It is the financial news media’s business to report new information. We all know that if they want to get people to tune in, the fastest way is to provide provocative and alarming headlines and commentary. So, we shouldn’t be surprised to see distressing news.

There are always many reasons for the stock market to trend up or down. It isn’t hard to write some narrative attempting to explain it. The reality is, there are all kinds of causes that create an effect. None of them alone drive price trends. Ultimately, what drives price trends is behavior and sentiment which drives supply and demand. Behavior and investor sentiment may be impacted by the news and what people decide to believe.

I often say “what you believe is true, for you” even if it isn’t actually true. A person’s beliefs could be completely wrong and could be scientifically disproven, but if they still believe it, it’s their truth, so it’s true – for them. So, whatever you choose to believe is going to be your truth, so I suggest weighing the evidence to determine the truth if you want it to be more accurate. In science, we can’t prove the truth to be true, we can only disprove it as untrue.

Let’s look at some truths that I believe to be true based on empirical observation of facts.

The biggest news headline is probably the government shutdown. There have been twenty U.S. government shutdowns over the budget since 1976 by both political parties. Half of the time it was followed by stock gains and half the time declines. The average result is -0.40% and the median is 0%. So, historically a government shutdown hasn’t seemed to drive prices. Below is the table. It is what it is.

What does the stock market do after government shut down

Yesterday evening Steven Mnuchin, the 77th Secretary of the Treasury, tweeted a note that he had called the nations six largest banks to confirm they have ample liquidy for consumer and business lending and other market operations. The words “Plunge Protection Team” started trending in social media. Much of the response has been negative, which seems odd to me.

Since when was doing “channel checks” not a good idea?

It seems not doing it would be imprudent…

There are many things going on all over the world all the time, so we can always find narratives to fit the price trend and believe it’s the driver. Narratives and news also seem to drive more emotional responses since people like to hear a story. I focus on the data, which is the price action. Whatever is driving the markets is reflected in the price trend. The price trend is the final arbiter. Nothing else matters.

The Morningstar table of index performance shows the 2018 total return of large, mid, small cap stocks along with growth, value, and blend.

STOCK MARKET INDEX RETURNS 2018

The most popular broad-based indexes like the S&P 500 and Dow Jones Industrial Average show 2018 is ending just the opposite of the way it started.

stock index performance return 2018

Let’s look at some price trends.

Yesterday I shared the Bullish Percent measures on the broad stock market indexes and each individual sector. We observed the percent of stocks in all sectors except for the Utility sector was already at historical lows after previous market declines. After today’s price action, we have some updated observations to explore.

The S&P 500 is in a bear market, commonly defined as a -20% decline from a prior price peak. What is most interesting is how fast it reached -20%.  In the chart below, I included the S&P 500 Total Return Index (including dividends), the S&P 500 Index price only, and the S&P 500 ETF (SPY). On a total return basis, the S&P 500 Total Return Index that includes no costs or fees didn’t quite close down -20% from its high, but the rest did. It’s close enough.

bear market 2018 October November December Crash

Though the stock indexes had declined -10% earlier this year, they had recovered to new highs by September and it appeared the primary uptrend would resume. Starting in October, the stock market declined again and attempted to recover twice in November. What came next was probably most shocking to those who follow market seasonality; the stock indexes are down over -15% in the month of December, which is historically one of the strongest months of the year. It seems this decline happening so fast and at the end of a calendar year is going to make it seem more significant.  Because it’s at year end it results in a “down year” instead of having time to recover during the normally seasonally strong period after October. The period from November to April historically has stronger stock market gains on average than the other months. Not this year.

The Utility sector reverses down to participation in the market decline. 

Yesterday I had highlighted the top range of the Bullish Percent chart in yellow to mark the high-risk zone above 70%. After today, the Utilities sector has declined below that range. Individual Utility stocks are now participating in the stock market decline.

Utilities Sector ETF XLU BULLISH PERCENT RELATIVE STRENGTH MOMENTUM

The Utilities sector ETF declined over -4% today and is now slightly down for the year.

Utilities Select Sector SPDR® ETF $XLU

During significant market declines, diversification sometimes isn’t the crutch it is promoted to be by most of the investment industry. Broad asset allocation and diversification do not assure a profit or protect against a loss in a declining market. In declining markets, we often see price trends cluster more as serial correlation. That is, prices begin to fall more just because they are falling. Investors sell because prices are falling. So, stocks, sectors, and markets can all become highly correlated to the downside. By the end of a market decline, all stocks, sectors, and markets are often participating.

The upside is, this panic selling is capitulation as the final weak holders stop resisting and begin to “sell everything!” We eventually see the selling dry up and buyers step in with enthusiasm at lower prices.

In the big picture, as I said in An exhaustive analysis of the U.S. stock market I guess we shouldn’t be surprised to see prices falling with greater velocity since this is an aged bull market at high valuations and the same Fed actions that probably drove it up are probably going to reverse it in a similar fashion. I started this year warning of complacency from the 2017 low volatility uptrend and the potential for a volatility expansion. I also pointed out during the stock market peak in September that volatility had contracted to a historically very low level in VIX shows the market’s expectation of future volatility. Specifically, on September 25th I wrote,

“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.”

I ended it with;

“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.”

Well, that has turned out to be an understatement I guess.

What’s more important is what I actually did. On August 23th as the stock market began to appear overbought on a short-term basis, I took partial profits on our leading momentum stock positions. In hindsight, it would have been better to sell them all. By September 26th (when I wrote the above) I had reduced our exposure to only around 30% stocks and the rest in Treasury bonds. It still didn’t turn out perfectly as the stocks we did hold declined, too, and in many cases even more than the stock indexes. As we entered October, I shared a new observation “Here comes the volatility expansion” as stock prices fell and volatility increased. As prices fell to lower and lower levels, I started adding more exposure. At this point, prices have broadly become more and more extremely “oversold” and sentiment has become more negative. This has been a hostile period for every strategy, but I’ve been here before.

By the way, I have been a tactical portfolio manager for over twenty years now. The highlight of my performance history has been the bear markets. I executed especially well in the October 2007 to March 2009 period when the S&P fell -56%. My worst peak to trough drawdown during that period was only -14.3% and I recovered from it about six months or so later. That was compared to a -56% drop in the stock index that took several years to recover. In fact, I did so well at a time when very few did that it was almost unbelievable, so I had my performance verified by a third party accountant. I have considered writing about it and sharing the commentaries I wrote during the period and the tactical decisions I made. Make no mistake, it wasn’t easy nor was it pleasant. I didn’t lose the money others did, so I was in a position of strength, but it was still a challenging time. What I will tell you is I entered and exited various positions about seven or eight times over that two year period. We never know in advance when the low is in, or when a trend will reverse back down. Buy and hold investors just take the beating, I entered and exited hoping the average gain exceeds the average losses. The swings are the challenge. It takes great discipline to do what needs to be done. Most people had very poor results, for me to create good results, I necessarily had to feel and do the opposite of most people. The market analysis I’m sharing here as observations aren’t necessarily the exact signals I used to enter and exit, but they are part of the indicators I monitored during the crash. Every trend is unique. We have no assurance my methods will do as well as in the past. But, the one thing I feel confident in is I’ve been here before. This ain’t my first rodeo. I know what I’m doing and I’m disciplined in my execution. That’s all I can do. I’m dealing with the certainty of uncertainty, so I can’t guarantee I’ll do as well the next time around, but I am better prepared now than I was then.

So bring it. Get some. I’m ready. 

Yesterday I shared the extreme levels of Bullish Percent indicators for the broad market and sectors as well as other indicators like the Put/Call Ratios. I want to add to these observations with more indicators reaching an extreme. I’ve not seen these extremes since 2008 and 2009.

The Nasdaq has declined the most which is no surprise since it’s mostly emerging companies and heavily weighted in Technology. Market conditions have pushed the number of Nasdaq stocks hitting new lows to over 1,100 as of last week. Since the total number of Nasdaq issues is about 3,200 that has caused the value, in percentage terms, to jump to over 30% of the total. As you can see, the last time this many Nasdaq stocks hit new lows was the October 2008 low and the March 2009 low. The current level has exceeded other corrections since then and even the “Tech Wreck” after 2000. At this point, it becomes a contrarian indicator.

NASDAQ NEW LOWS PERCENT OF INDEX

To no surprise, the same trend is true for NYSE stocks. As of last week, the percent of stocks listed on the New York Stock Exchange at new lows has reached the levels of past correction lows, but not as high as the 2008 period.

NYSE NEW LOWS PERCENT NYA INDEX

From here, I’ll share my observations of the relative strength and momentum of the sectors and stocks within them so we can see how oversold they have become. We already looked at the Bullish Percent of each sector yesterday, this is just more weight of the evidence.

First, I applied the Relative Strength Index to the S&P 500 daily chart. This RSI is only 14 days, so it’s a short-term momentum indicator that measures the magnitude of recent price changes to estimate overbought or oversold conditions. RSI oscillates between zero and 100, so it’s range bound and I consider it overbought above 70 and oversold below 30. Below we see the current level of 19 is very low over the past twenty years and is at or below the low level reached during past shorter-term market bottoms. However, we also see during prolonged bear markets like 2000 to 2003 and 2007 to 2009 it reached oversold conditions two to three times as the market cycles up and down to a lower low.

RSI SPX RELATIVE STRENGTH S&P 500 INDEX

Zooming out from the daily chart to the weekly chart, we see the extremes more clearly and this is one of them. On a weekly basis, this oversold indicator is as low as it’s been only at the low points of the last two major bear markets.

sS&P 500 RSI WEEKLY RELATIVE STRENGTH SPX

Zooming out one more time from the weekly to the monthly chart, we observe a monthly data point only highlights the most extreme lows. It’s the same data but ignores the intra-month data. On a monthly basis, the current measure isn’t as low as it reached at the bear market lows in March 2009 or October 2002. For it to reach that level, I expect the green area I highlighted in the price chart to be filled. In other words, this suggests to me if this is a big bear market, we could ultimately see the price trend decline to at least the 2015 high. It only takes about -10% to reach that level. However, as we saw in the shorter term readings, if history is a guide, it would most likely cycle back up before it would trend back down.

RSI S&P 500 MONTHLY RELATIVE STRENGTH INDEX SPX

You can probably see why I stress that longer-term price trends swing up and down as they unfold. Within a big move of 50%, we see swings around 10 – 20% along the way.

Let’s continue with this same concept to see how each sector looks. The broader indexes are made of the sectors, so if we want an idea of the internal condition of the broader market it is useful to look at each sector as I did yesterday with the Bullish Percent indexes.

Since we just had a -15% correction in August 2015 and January 2016, we’ll just focus on the daily RSI looking back four years to cover that period. Keep in mind, none of this is advice to buy or sell any of these sectors or markets. We only provide advice and investment management to clients with an executed investment management agreement. This observation is for informational and educational purposes only.

The Consumer Discretionary sector is as oversold as it’s been at historically low price points. A trend can always continue down more and stay down longer than expected, but by this measure, it has reached a point I expect to see a reversal up.

CONSUMER CYCLICAL SECTOR RELATIVE STRENGTH MOMENTUM RSI TREND

The price trend of Consumer Staples that is considered to be a defensive sector initially held up, but then the selling pressure got to it. It’s oversold as it’s been at historical lows.

consumer staples etf relative strength trend RSI XLP

The Energy sector has declined the most in 2018 and is oversold similar to prior price trend lows. We can see the indicator isn’t perfect as a falling trend sometimes reverses up temporarily, then trends back down to a lower low only to get oversold again. We’ll observe this same behavior at different times in each sector or market.

energy sector etf xle relative strength rsi momentum trend following buy signal.jpg

The Financial sector is deeply oversold to the point it has reached at prior lows. Any market could always crash down more, but Financials have reached a point we should expect to see at least a temporary reversal up.

FINANCIAL SECTOR ETF XLE IYF RELATIVE STREGTH MOMENTUM RSI

Healthcare is a sector that isn’t expected to be impacted by the economy, but it has participated in the downtrend. It’s also reached the oversold point today. You can see what happened historically after it reached this level. If history is a guide, we should watch for a reversal.

XLV HEALTH CARE ETF RSI MOMENTUM RELATIVE STRENGTH

The Industrial sector is trending down but has now reached a point we could see a reversal back up.

XLI INDUSTRIAL SECTOR ETF MOMENTUM RSI

Clearly, the market decline has been broad as every sector has participated. The Materials sector reached the oversold level today.

XLB BASIC MATERIALS SECTOR ETF RSI MOMENTUM RELATIVE STRENGTH

Real Estate has not been spared during the selloff. It has now reached an oversold level normally seen at lows, but historically it’s cycled up and down a few times before reversing up meaningfully. That can be the case for any of them.

XLRE REAL ESTATE ETF IYR MOMENTUM TREND FOLLOWING RSI

The Technology sector had been one of the best-looking uptrends the past few years. It’s now oversold after today’s action.

TECHNOLOGY ETF XLK IYR MOMENTUM RSI RELATIVE STRENGTH ASYMMETRIC RISK REWARD

Up until today, the Utility sector was the lone survivor, but it was one of todays biggest losers. It’s falling so sharply so fast it’s now oversold with the other sectors.

XLU IDU UTILITIES UTILITY SECTOR ETF ETFS MOMENTUM RSI

After prices have declined, I look for indications that selling pressure may be getting more exhausted and driving prices to a low enough point to attract buying demand. That’s what it takes to reverse the trend.

I’ve been here before. I’ve executed through these hostile conditions as a tactical operator. The more hostile it gets, the more focused in the zone I get. After the stock market has already declined, I start looking for this kind of panic selling and extreme levels for a countertrend. We’re seeing those levels now. Sure, it could get worse, but we have reached a point that lower prices are more and more likely to result in a reversal back up.

I’m just going to do what I do.

Have a Merry Christmas!

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

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

 

What’s going to happen next for the stock market?

The popular stock indexes are now down about -5% year to date.

dow jones stock market

The popular stock indexes are now about -13% off their highs.

stock market dow jones spx spy dia

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.

nasdaq russell 2000 dow jones

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.

emering markets stocks

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.

BOND ETF TLT LQD AGG ETFS

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 sentiment fear greed index

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.

fear and greed over time investor sentiment stock market

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.

bearish investor sentiment

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.

bearish sentiment

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.

Shiller PE ratio for the S&P 500

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.

percent of stocks above 50 day moving average

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.

stock market breadth percent of stocks 200 day

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.

buliish percent index

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.

stock market 2015 2015 decline bear market

Looking closer at the % off highs, we see the late 2015 decline was -12% and the first few months of 2016 was about -15%.

stock market decline 2015 2016 asymmetric risk reward

Here is 2018. So far, it isn’t actually as much of a decline.

bear market stocks stock market

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.

VIX VOLATILITY expansion 2016

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.

divergence volatility expansion vix

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.

The stock market is swinging its way to an inflection point

Trying not to sound like a broken record, I’ll share a few updates from what I said last in Observations of the stock market downtrend. 

The stock market is at an inflection point. An inflection point is a time of meaningful change in a situation; a turning point. The reality is, there are many inflection points within market cycles and price trends. So, we observe different inflection points across different time frames. For those who watch the stock market daily as a professional portfolio manager, we observe every move. But, the overall focus needs to be on the bigger trends. Every market cycle and price trend is made up of smaller cycles as prices swing up and down on their way to forming a directional trend. Market cycles don’t trend straight up or down.

The U.S stock indexes have dropped about -10% in October, giving up gains for the year. Many investors probably believe October is historically the worst month of the year for the stock market because of famous October declines. September is actually the worst month historically, but October is historically a volatile month. It just so happens, this decline occurred inside of October.

I don’t use seasonality as a signal for my decisions, but we’ve all heard of “sell in May and go away.” The period from May through October is supposed to be the weak season and November to April is the stronger season for stocks. The S&P 500 had defied the expectation that stocks would be weak last summer and gained nearly 10% from May through September, then lost the gain in October. Many leading growth stocks that previously showed the strongest momentum declined even more than the stock indexes. I pointed out a few months ago that international stock indexes including both emerging and developed countries were already in downtrends. So, the global equity markets were generally down in October.

That’s the bad news for anyone invested in these markets.

The good news is after those who wanted to sell have sold, prices eventually reach a low enough point to attract new buying interest.

I focus on what the price trends are actually doing, so I’ll share my observations of the trends and update some sentiment and breadth indicators I’ve discussed in previous observations.

First, we look at what the price trend is actually doing. Below is the S&P 500 stock index year-to-date. We see after declining about -10% from its September high, the stock index has reversed back up to the price of the prior low on October 11th.

 

In technical analysis of price trends, we say “prior support may become resistance” and that may be what happens next. We shouldn’t expect prices to trend straight up or down, they swing up and down. Prices making higher highs and higher lows form uptrends or lower lows and lower highs form downtrends. So, it wouldn’t be abnormal to see the stock index trend back down to the low again, or it could pause and continue the recent upward direction.

For a sustained move higher, those who want to sell need to have sold and prices need to have reached a low enough point to attract new buying demand.

Have those who want to sell, sold?

To get an idea for observation of investor sentiment, we can look at a few simple indicators. I explained the thinking behind the Fear & Greed Index in Observations of the stock market downtrend.

The Fear & Greed Index is based on 7 indicators of investors sentiment and can be a useful gauge to help investors keep their own sentiment in check. It currently remains at an “Extreme Fear” level, which is typical after a stock market decline and a high level of bearish sentiment that has historically preceded stock prices reversing back up- as those who want to sell have sold. However, in a prolonged bear market, this oscillating indicator could stay low for a long time or it could swing up and down along with price trends.

But, nothing illustrates buying and selling, supply and demand, better than the actual price trends. Another interesting indicator I’ve shared in recent observations is the percent of stocks in the S&P 500 that are trading above their short-term moving average.

 

It shows us how many stocks have participated in an uptrend or downtrend. When it reaches a high point and most stocks have participated in an uptrend, it may be nearer a reversal back down. Price trends don’t move straight up. When it reaches a low level is indicates most stocks have declined and at an extreme, it can suggest capitulation – those who want to sell may have sold. But, prices don’t trend straight down. Prices swing up and down along the way to drifting directionally. At this point, this indicator has reached the February and April lows and reversed up.

Shorter term, it’s an inflection point as I highlighted. If more stocks trend back up, we’ll see this trend higher.

Let’s see how it all unfolds…

 

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.

Observations of the stock market downtrend

Observations of the stock market downtrend

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.

stock market trend

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.

fear greed index investor sentiment behavioral finance

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.

fear and greed back test over time investor sentiment indicator

I believe investor behavior is both a driver of price trends, but investors also respond to price trends.

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

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.