Expectationsblogbnr

After many years writing the mantra "pray for a correction" some readers have responded with consternation that I can stop now that it’s here.

Others have suggested I should consider a more agnostic perspective in future.

I understand their concerns. But I also stand by the idea that this is the best medicine we could ask for in order to extend the life of this climb up this financial mountain, because we’re not even at Base Camp 1 yet.

A Truckload of Straws...

As the week ended with another crescendo of selling into the close, it’s become clear that we are being driven by a) emotions, and b) computer algorithms.  

They feed on each other with computer trades making up roughly 90% of activity last week.

How do we know that’s true?  

Because it’s always the same linchpin as washouts occur: Fear and emotions coupled with ‘natural’ human behaviour towards money.

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You might want to grab your egg nog for these charts (above).

The top chart shows bearish sentiment, while the bottom shows how bullish investors are feeling, according to the American Association of Individual Investors (AAII).

For reference, this data goes back decades and serves as a base of valuable contrary market signs (at extremes) for the long-term, patient investor.

Now, the red jagged line going from lower left to upper right on each is the S&P 500 Index price overlay.

The Lessons?

At last measure we had:

  • 48.9% Bear, and

  • 20.9% Bulls (or nearly 2.5 to 1 bears over bulls).

For perspective, that ratio is hugely important as it represents an extreme very rarely reached. In other words, 80% of the crowd does not like stocks for the coming year.

And strong feelings at this type of extreme have rarely if ever been right for very long.

Check it out for yourself. Look at the previous strong readings (highs in Bearish sentiment in the top image, and lows in Bullish sentiment on the bottom).

Now ask yourself this: The purple line shows you that we have only seen higher readings a few times since the 2009 collapse.  Were those other time periods lows or highs in price?

Let your eye follow the peak in the readings (the other few times above the purple line) and then gaze at the corresponding action of the red line at the same time.

What the S&P 500 was about to do is the key ingredient.

Second Chart – Same Exercise

The purple line shows you that we have only seen lower readings - technically 3 times - since the 2009 catastrophe and "end-of-the-world-as-we-know-it" price lows.

So, were those readings at lows or highs in the S&P price?  

Well, once again let your eye look at the low points (below the purple line) in the data and then gaze at the corresponding actions of the red line at the same time.

What the S&P 500 was about to do is once again the key ingredient.

And There’s More…

Before we get to even more contrary, emotionally-driven data, let's make sure we do not overlook the latest on the earnings front.  Keep in mind, this includes every single perceived (whether true or not) slowdown rumour reported into Friday's close:

  • The SP 500 is down roughly 10% - 11% from its late September '18 high and yet market bearishness stands at its highest levels in more than 6 years.

  • Meanwhile, here is the S&P 500 earnings data: (from IBES)

  • Forward 4 quarter estimate: $170.53 vs last week’s $171.05

  • PE ratio: 15x

  • PEG ratio: 1.9x

  • S&P 500 earnings yield: 6.56% vs last week’s 6.50%

And the other side of the risk market, the 10-year bond yield, is down to 2.895%.

Now, with those impressions simmering in your mind, consider this:

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The data above is pulled from the very same download you can grab at aaii.com. It takes you back to the Tech Bubble Lows of early 2003, when everyone swore off stocks. And of course it was dreadfully certain that stocks and our economy were finished.  

Note the lowest readings at the time, after a 70% collapse in prices and an 18-month downtrend for tech.

The red arrow shows two things:

1) The lowest reading then (21.1%) is higher than where we are now.  In other words, the crowd is less bullish at Dow Jones 24,000 than it was at Dow Jones 3,000 after a complete tech collapse, and

2) The low reading actually came before the low in prices which, at the green arrow, was early March 2003.

Now there’s good lesson in contrarian thinking!

 

Mike_williams
Author
Mike Williams
Founder and Managing Partner of Genesis Asset Management, New York