June 20, 2014
By Steve Blumenthal
“The concept behind investor sentiment is that the stock market tends to be a manifestation of group psychology in motion. Highs tend to coincide with extreme group enthusiasm and lows coincide with excessive group fear. At extremes in opinion, the stock market majority is usually wrong.” – Ned Davis Research
I remember sitting on the edge of my seat, fully engaged. I was at the Union League in downtown Philadelphia in 1985 listening to Sir John Templeton share his wisdom on investing. “I’m going to tell you the secret to my success,” he said and added, “what I am going to tell you will sound so simple; however, it will be one of the most challenging things for you to do. If you can master it, you will be among the very best.” He summed it up saying, “The secret to my success is that I buy when everyone else is selling and I sell when everyone else is buying.”
I rushed back to my cubical with excitement only to be told by my manager to sell the stock of the day. It was usually something that was popular with a good story. It was easy to sell because it was what everyone was buying. Hmmm.
New highs in the S&P and DJIA in the last four weeks have turned the retail investor from cautious bear to a bull market believer. Optimism, as measured by the American Association of Individual Investors Poll (“AAII”), shows extreme retail investor optimism. This particular look at sentiment has been one of the last to convert to extreme optimism.
Statistically, since August 7, 1987, the S&P 500 gain per annum is 0.00% when individuals, as measured by the poll, are excessively optimistic. What is more interesting is the data when individual investors are extremely pessimistic. The gain per annum when investors are pessimistic is 10.5%. Best to be a buyer when everyone else is a seller. You’ll find the chart via the Trade Signals link below.
This week, I wrote an article for Forbes on using PE as a way to measure overall market risk. The idea is that there are times to be more aggressive and times to be less aggressive. PE and other fundamental valuation calculations can help you see if we are in a high risk or low risk regime.
Making money is really about understanding how investment returns compound over time. We have had two 50% corrections in the last 14 years. It takes a 100% return to overcome a 50% decline. Risk management is about participating in the up moves while smartly protecting against large down moves. Use investor sentiment and a common sense view on high and low valuations to determine how you shape your portfolio and if you should risk protect your equity exposure in some way.
Ultimately, make sure you will be in a position to take advantage of opportunities that the next crisis creates. Yes, there will be a next market crisis. When and from what level – don’t know. Today, the markets are expensively priced and investor sentiment is high today. Get the risk management right. It’s important and not too difficult to do.
Included in this week’s On My Radar:
- Stock Markets High PE Suggests Lower Returns, Forbes – by Steve Blumenthal
- A New Record Low Yield for High Yield Bonds
- Fed looks at exit fees on bond funds – Nothing short of amazing (frankly, crazy)
- Trade Signals – AAII Investor Sentiment and other Sentiment Charts
Stock Markets High PE Suggests Lower Returns, Forbes – by Steve Blumenthal
With the stock market setting new highs, investors face unusually tough choices. An examination of historical valuations points to low forward returns for the U.S. stock market. Normally, bonds would provide a safe harbor, but interest rates are still near historic lows. They will not provide the same portfolio protection as in years past and, worse, bond prices will decline when interest rates rise.
It is tricky to structure a portfolio in the face of these risks but there are moves you can make right now.
I share four ideas as to what you can do today.
Click here for the full article.
A New Record Low Yield for High Yield Bonds
At just 4.94%, the yield on the Bank of America Merrill Lynch U.S. high yield index slipped below its record-low level set 13 months ago. Maybe more importantly, underlying Treasury yields are approximately 75 basis points higher today than they were when the last record low in the high yield market was set in May 2013. Treasury rates are higher now than they were then and high yield bond yields are at a new record low.
The chase for yield has driven investors into riskier assets. It would be good to remember that life felt pretty rosy in 2008. Not too long after, yields went to nearly 20% while spreads widened to 18%.
Just keep buying (I say factiously) while you note the next section. The Fed has driven investors into riskier and risker asset classes and now wants to possibly set in place a gate to not let you exit. Add this to your growing list of unusual and manipulative behavior.
Fed looks at exit fees on bond funds
Watch for the race to the exit doors if this happens. The following from Art Cashin’s “Comments” this past Tuesday.
Bizarre Headline #1 – Our friend, Wall Street icon, Jeff Saut of Raymond James wrote yesterday that we seem to be living in a “Bizarro World” where everything is opposite of normal expectations. He began his piece with this very apt quote from the HBO series The Newsroom:
“We stood up for what was right. We fought for moral reasons. We passed laws, struck down laws for moral reasons. We waged wars on poverty, not poor people. We sacrificed, we cared about our neighbors, we put our money where our mouths were and we never beat our chests. We built great big things, made ungodly technological advances, explored the universe, cured diseases, and cultivated the world’s greatest artists and the world’s greatest economy. We reached for the stars, acted like men, we aspired to intelligence, we didn’t belittle it, and it didn’t make us feel inferior. We didn’t identify ourselves by who we voted for in the last election and we didn’t scare so easy. We were able to be all these things and do all these things because we were informed, by great men, men who were revered.” Jeff Daniels, delivering a biting soliloquy on American decline. (HBO’s The Newsroom)
In the last few days, I’ve seen several headlines that certainly seemed bizarre to me. Here is one from today’s Financial Times: Fed looks at exit fees on bond funds
“Federal Reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors, underlining concern about the vulnerability of the $10tn corporate bond market.
Officials are concerned that bond funds are becoming “shadow banks”, because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter.”
What they are really saying is there is a bubble in the bond market and an exit panic will push rates higher than desired. This is a problem for a global public sector, including the U.S. Government, overleveraged and dependent of debt. These are problems that happen at the end of unprecedented manipulation. Keep this story on your radar screen.
Cashin concludes, “Considering surcharge to prevent panic withdrawals? What kind of panic might start if word leaks out before the surcharge is set.” Right on, brother.
Trade Signals – Extreme Investor Sentiment Optimism (Bearish)
The cyclical trend remains bullish for both the equity and fixed income markets. However, Investor Sentiment is convincingly in the extreme optimism zone.
Click here for a link to Wednesday’s Trade Signals.
Conclusion
In today’s higher-risk environment, the goal now is not only to invest for growth, but to feel more secure – and less emotional and better positioned to take advantage of the opportunities that the next crisis will create. This calls for an awareness of underlying risk and the inclusion of strategies to mitigate the risk.
Valuation measures like PE ratios may not be perfect timing tools, but they are great gauges of relative risk. Today, risk is high.
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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