Bull or Bear? Watch This Clue

We’re moving closer to a bear market, but for now, we’re expecting the markets to climb higher

Last week had some rough spots.

Watching the markets convulse on Wednesday was uncomfortable at best.

We’re aware that more than a few subscribers were rattled, wondering if the volatility, the inverted yield curve, and the trade war are all pointing toward one thing — an impending bear market.

Today, let’s address this. Interestingly, the very fear that motivates such a question could point toward why the answer is “no, we’re not yet there.”

 

***Imagine you hopped in a time machine and returned to November 1992

The U.S. economy is clawing its way out of the 1991 recession. As part of this, auto sales have been in the toilet — they’ve pulled back to a level that would end up being the low point for the ensuing 16 years.

Investment pundits are bearish on the auto industry. Investors are bearish. And why not? There’s not a lot of great news here.

Capturing this negative sentiment is a TIME magazine cover story: “Can GM survive in today’s world?”

 

Now, you hop back into your time machine and time-travel to December 1993. The U.S. economy is getting stronger. As part of this, auto sales have bounced back.

You pick up a new copy of TIME magazine and see the three CEOs of the “Big 3” U.S. automakers. The title has a far more optimistic ring this time: “The Big Three — How Detroit is shifting into high gear“.

 

 

Now, remember, only 13 months have separated these two cover stories. But the emotional charge related to each is diametrically opposite.

To me, “Can GM survive in today’s world?” feels despairing, calling into question GM’s basic survival, while “The Big Three — How Detroit is shifting into high gear” feels full of hope, optimism, and confidence.

 

***So, which would have been the better time to buy GM stock? At the point of despair or the point of hope?

To begin, you note how GM shares were trading around $28 in November 1992. By December 1993 they had climbed to just a bit above $55.

Nice! That’s getting close to doubling your money! And remember, that’s coming out of the “despair” period. So, certainly, the gains coming out of the “hope” period will be even better, right?

Not so much …

By December of 1994, just 12 months later, GM shares had fallen by about one-third, back to $35.

This is not a coincidence.

 

***Whether on a stock-specific basis, or for markets in general, “tops” tend to form when investors are wildly-confident, bullish, and greedy, while bottoms are typically carved out when investors are despairing and hopeless

 

For example, there’s Greenspan coining the phrase “irrational exuberance” to describe investor sentiment during the 90s Dot-Com run-up. This paralleled the classic magazine cover from Newsweek in 1999, capturing the greed and “fear-of-missing-out” that accompanied the era (published just months before the markets collapsed).

 

 

So, with all of this in mind, how did you feel this past week as the market roiled?

I’m guessing there was some significant anxiety.

Pulling back, how have you felt over the past 6-12 months?

Has it been euphoric? Greedy?

I’d guess that for most of us, the answer is “no.”

The question then becomes “if lots of investors are feeling fear, can we use that as a clue that’s actually pointing toward … more gains, at least for a bit?”


***The impact of emotion on market dynamics

Prior to joining InvestorPlace, I worked with a quant investor named Meb Faber, occasionally co-hosting a financial podcast with him.

One of our guests was Jason Goepfert, founder of the investing service, SentimenTrader. Jason studies the impact of human psychology on the financial markets, using a series of indicators to give him an idea about where the markets might be going next.

In preparing for our podcast with Jason, Meb and I had a discussion which delved into investor sentiment, fundamental analysis, and bear market crashes. In essence, we were wondering what’s the final prelude to a bear market?

My kneejerk answer was “extremely high stock valuations.”

But as we chatted, it became obvious that nosebleed valuations, in-and-of-themselves can’t be the answer. After all, if investor sentiment and momentum is wildly bullish, then the buying continues. What was “extremely high stock valuations” quickly becomes “absurd, laughable, egregiously-high stock valuations.”

So, investor sentiment trumps stock valuations.

This awareness then focused Meb and me back to emotion, and we found ourselves wrestling with one fundamental question:

Is “irrational exuberance” a requirement for a bear market to strike?

The idea is that when investors are irrationally exuberant, that enthusiasm draws practically all investors off the sidelines and into the market. And when everyone is invested, and there’s no one left who’s willing to buy at nosebleed prices, that’s when the bubble bursts.

In our interview with Jason, as well as other guests on later podcasts, no one was willing to cede that “yes, irrational exuberance is an absolute requirement for a bear market.” As Jason said in his interview, there have been many different bear markets throughout history, and each one is slightly different — in cause, length, and magnitude.

That said, irrational exuberance certainly appears to be correlated, and its fingerprints are found on virtually all our past big bear markets in one way or another.

 

***I imagine this as a balloon inflating

If you continually pump the balloon full of air, at some point it’s going to pop. Similarly, if the investment markets are continually flooded with new capital without ever taking a breather, eventually some investors will recognize the lofty valuations and the accumulated gains, so they’ll sell, and this will lead to a fast, panicky “pop” that will burst the market bubble.

Back to the balloon … What if the person filling the balloon was scared of it popping? So, as it became increasingly inflated, he’d let some air escape from time-to-time? Obviously, that balloon won’t pop nearly as quickly in that case.

Days like last Wednesday, when the Dow plunges 800 points, are the equivalent of letting some air out of the balloon. Investor fear, which leads to sell-offs, takes pressure off the markets.

A recent CNBC article made this exact point, referencing the volatility from this past December:

On a more immediate basis, the current bull market is showing signs of having been refreshed by the panicky 20% drop late last year, which reset investor expectations much lower, prompted a dovish turn by the Fed and seemed to anticipate the economic slowdown that has shown up in recent data.

So, could it be that the persistent fear in the market today is keeping our balloon from getting too inflated? If so, how fearful are we?

Below is the Fear & Greed Index from CNN Business, taken last Friday (even as the markets were climbing).

Be sure to notice that “greed” isn’t anywhere on here. Both one month and one year ago, the reading was “neutral.”

Here’s a broader snapshot:

 

Returning to Jason, last Friday he wrote a blog post with a takeaway I found interesting.

From Jason (underline added by me):

More than a third of our indicators hit pessimistic territory by Wednesday’s close, the most in months. There was a drop in optimistic indicators as well, so the spread between them was the widest in more than six months.

 

It has become quite a bit wider in the past, but by the time it gets this wide, ending a long streak with a smaller spread,future returns for stocks have been mostly positive.

So, in an odd relationship, more fear often leads to more gains. After all, “stocks climb a wall of worry.”

***How then might we reconcile sentiment, valuations, yield curve inversions, future returns, and everything else that’s pushing and pulling the markets today?

In other words, how do we respond to the question at the top of this Digest— are we on the brink of a bear market?

Fortunately, we have some of the best analysts in the industry here at InvestorPlace to help us answer that. Collectively, they’ve been in the markets for more than 10 decades, and have racked up the largest portfolio of 1,000%+ returning recommendations of any investment publication I’m aware of, and in doing all this, have led subscribers to life-changing investment returns.

In my position here at the Digest, I see how they’re viewing the markets. And from a 30,000-foot perspective, their broad, collective takeaway mirrors what we just walked through regarding sentiment indicators — more likely than not, we’re just not at the top.

Yes, there’s volatility today. And markets could correct further. But once they hold support, our analysts agree the odds of more gains over the coming months are greater than those of a sudden bear market in our immediate future.

Now, yes, there are warning signs on the horizon, which we’ve noted here in the Digest. That’s why the further out in time we go, the more cautious we become, often highlighting Eric Fry and his Bear Market 2020: The Survival Blueprint. It’s also why we suggest rotating into specific trend-investments and hand-selected, fundamentally-superior stocks that will do well regardless of what’s happening in the broader market.

But do we anticipate a bear market tomorrow? Not if we go by the amount of fear today. And not if we go by the experience of our veteran analysts.

As 2019 continues, we’ll watch for changes in sentiment as well as signs of deteriorating fundamentals, but for now, we don’t see the bear right around the corner.

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2019/08/bull-or-bear-watch-this-clue/.

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