The Triumph Of Greed Over Fear

Discussion in 'Wall St. News' started by dealmaker, May 28, 2017.

  1. dealmaker


    Williams Market Analytics, LLC

    Long/short equity, momentum, newsletter provider, registered investment advisor
    Williams Market Analytics, LLC

    Another sharp daily drop, another slingshot rally.

    Greed is the dominant emotion in markets today.

    But has greed gone too far?

    It took less than one week for U.S. equity benchmarks to continue their parade of record daily closes after hitting an air pocket on May 17. Last Wednesday's one day wipe-out on the S&P 500 (-1.8%) and Nasdaq-100 (-2.5%) felt like a rush to exits was beginning. The news of the appointment of an independent counsel to investigate the Trump administration's ties to Russia, with some in Congress brandishing the possibility of impeachment, seemed like a legitimate threat to the "Trump rally". The VIX volatility index spiking +20% reinforced the notion that fear was returning to markets. However, this week we saw that greed reaffirmed its dominate position among investor emotions. No one wants to (or perhaps no one can afford to) miss any equity upside gains.

    Have U.S. equities become a martingale? That is, a sure bet. Even if most investors still recognize that there is downside risk in equities, buying any form of price dip has become an automatic winning trade. Call us old fashioned, but we are just too skeptical in buying a price dip, whatever the narrative provoking the selling. When we see a sharp daily sell-off, like seen last Wednesday or on March 21st, which broke below the trading ranges on the S&P 500, our first instinct is not to reach for the falling knife (as we can imagine most investors can relate to). This situation reminds us on a recurring scene from Charles Schulz's "Peanuts" comic strip. Lucy offers to hold the football forCharlie Brown to kick. Each attempt to kick the football ends up with Charlie Brown flat on his back after Lucy pulls the ball away. Yet each time Charlie believes in Lucy's coaxing and that "this time is the one", the long awaited opportunity to finally kick the football. Prudent investors waiting for a normalization of equity market have had to utter "good grief" many times these past years after a sharp sell-off has resulted in a slingshot rally. Consider this first "measure" of complacency versus fear. The S&P 500 hasa streak of 232 consecutive trading sessions without a 5% drawdown from the peak- the longest such streak since 1996 and the sixth longest since the inception of the S&P 500 in the 1950s.


    While a market correction almost never occurs when a large number of investors are anticipating (or hoping for) a drop in stock prices, it's hard to imagine that many big money players (fund managers, sovereign wealth funds, even central banks these days) are holding back at this stage. If a fund manager is not 100% in equities by now, for example, we doubt that more expensive equity prices will draw him/her into equity markets. Perhaps a deeper equity market correction will be needed at this stage to pull cash off the sidelines. But this is logical reasoning…emotions play a strong role in investment decisions and even professional investors break down and throw everything in when pricesseemlike they won't fall. And this is why equity bull markets peak in a buying climax.

    We updated two versions of our margin debt charts below. Margin debt, or borrowing money to invest more than the nominal value of a portfolio, is a classic warning sign at the end of bull markets. Margin debt also provides the fuel to accelerate a market decline as leveraged investors and funds are forced to close positions as they slip underwater. Data through the end of April shows that NYSE Margin Debt relative to GDP is once again above the ratio peaks in March 2000 and October 2007. A true long-term investor would only want to engage in buy-and-hold positions when the ratio fallsat leastbelow 2%, and preferably below 1.5%.


    In the next chart we create a "real" measure of margin debt, normalized for inflation, and compare it to real household income. With this ratio now at record highs, we can surmise that greed is at an extreme.


    The ratio of blue chip S&P 100 (NYSEARCA:OEF) stock to riskier small cap stocks comprising the Russell 2000 (NYSEARCA:IWM) is another decent, market-based metric of greed and fear. We calculated that 89% of the S&P 500 (NYSEARCA:SPY) gains since the 2009 low have occurred when the S&P 100 has been in a relative downtrend compared to the Russell 2000, as shown by the red 50-day moving average line in the chart below. The 50-day moving average of the ratio of these indexes has passed an inflexion point in recent weeks. As long as small cap weakness persists, it is unlikely that equities will charge higher.


    Finally, we noted in our article "The S&P 500 or The S&P 495" that just five stocks have been driving large cap index gains. Another classic sign we tend to see at market tops is narrowing leadership. Our last chart looks at the percent of stocks on the NYSE closing above their 200-day moving average (blue curve). Two points of interest. First, the percent of stocks above their 200-day moving average recently peaked on February 21st at 72.3% (currently at 57%). In other words, the U.S. equity gains since mid-February have occurred with narrowing participation. Second, comparing the percent above 200 curve to the NYSE Composite index price index (red curve), we see that the two major corrections in this bull market occurred when the percent above 200 has formed a negative divergence with the index price.


    In the very near-term, risk-on sentiment remains healthy, but below the extreme readings ourComposite Market Risk Indicatorshowed in the weeks following the U.S. election. We doubt that equities are currently at a sentiment top.


    We are dealing with a bull market on steroids, built on central bank asset purchases and inappropriately low interest rates. Some have speculated that about 800 points on the S&P 500 are attributable to central banks. That's a lot of air under the market. Greed today has been driven, to a large extent, by faith in the ability and willingness of central banks to administer financial markets. Nevertheless, we do not believe that "this time it's different". Central banks can neither eliminate economic recessions nor create a permanent plateau of prosperity in equity markets. Indicators such as margin debt shown above andvaluationswill triumph in the end. In the meantime, financial market distortions continue longer than anyone could have expected. For those buying equities today, heed these trader words of wisdom:"If stock prices fall a little, go ahead and buy. If stock prices fall a lot, then sell".
  2. That's a hedged statement ever there was one.

    Conveniently leaving out their definition of ... a little ... and .... a lot.
    dealmaker likes this.
  3. Handle123


    dealmaker said:
    For those buying equities today, heed these trader words of wisdom:"If stock prices fall a little, go ahead and buy. If stock prices fall a lot, then sell".

    Really, does not matter where you buy so long as one is hedged, the risk is actually less if price has fallen a lot. You all think in terms of profits, whereas if you thought in terms of risk first, you would see life as a trader to be different.

    Definitions of "Greed and Fear" to me equal "Idiotic and uneducated", if you too "Idiotic" and going for last nickel can cost you thousands by being a Hog. Fear comes from lacking education of knowing the answer before the question. Brainstorm for few hours of all the wrong things that can happen to your trade you be in, THEN figure out a rule for you to follow for each question before it happens, thereby fear is gone.
  4. dealmaker


    I think markets are full of contradictions eg "buy low sell high" contradicts with "trend is your friend" thus instead of universal applicability we should look at context.
  5. Nonsense.

    Risk is not defined in a vacuum by just current price.
  6. Handle123


    Do you drive a car, have insurance, do you know when you will need this insurance? And depending on deal you get, you can get a car that is one year better than what you were driving. SO it just like the stock market, you never know when you going to need that insurance.

    But the great thing about trading is all the ways it can be done.
  7. That has nothing to with what you said earlier.

    Risk is of an event happening. Just because a stock has fallen "a lot" does NOT mean it is now less risky for it to fall further. Actually it is the opposite after a price drop - at a greater risk of falling even more. Maybe a lot more.
  8. Handle123


    "event happening" ??? So over valued is considered event happening? So any move whether up or down is considered "event happening"?

    If a stock drops 50%, you think the risk is higher than stock is twice as high? The hedge will cost me less at lower price. And so what if it drops more? If you know how to hedge, the risk will be negotiable.
  9. birzos


    Not entirely sure what the point of their post is because it's disjointed, however it's very simple, either a seismic collapse or a new round of exponential QE.

    Exponential yield curve
    Source: Analysis of Central Bank QE Programs.pdf

    And another one

    And another.

    The trick is knowing what happens at the peak of the exponential curve! We seriously need to hire more analysts.
    Last edited: May 29, 2017
  10. This is really, really basic.

    Valuation is not an event except maybe when some BS Wall Street anal-yst lowers /raises a rating. An Event (capital E) is a sudden unexpected fast price drop or rise. An Event is a during the trading day breaking news occurrence (company or commodity specific, political, Fed or Economic Report day, terrorist or war related, weather, black swan, etc).

    The risk is of the trading going against you, whether or not you are hedged. Not how much capital is used for the trade itself. But obviously if you are hedged properly the risk should be lower. Though ask the folks at LTCM how that worked for them.

    Again stocks that drop 50% are more likely to drop further .... because obviously that is the current momentum and also simple math says a 50% drop needs a 100% gain to get back to break even, all the while there is overhead supply in the form of buyers sitting above wanting to get out at breakeven. Which means there has to be a lot more willing buyers going up than there were willing sellers going down. It does happen. Just it is a lot easier going with momentum than against .... just because something "is on sale".

    - A particular price point <> Risk. -
    Last edited: May 29, 2017
    #10     May 29, 2017