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Brad Lamensdorf, the founder and portfolio manager of Active Alts, is a principal and co-manager of the AdvisorShares Ranger Equity Bear ETF. He previously managed a long-short investment partnership from 1998-2005 under the name Tarpon Capital Management. Earlier in his career Mr. Lamensdorf was an equity trader/market strategist for the Bass Brothers’ trading arm. He managed a short only portfolio in addition to co-managing a $1bil hedging program. He also served as in-house market strategist for the entire internal and external network of Bass Brothers money managers.
Short-term investor sentiment has turned bullish. The CNN Fear/Greed at 13means investors are very fearful. The Ned Davis Research short-term gauge is at 13. Both are very bullish signals from a contrarian point of view because investors are historically wrong about market direction.
Meanwhile, intermediate term sentiment also is looking more bullish. The NDR crowd sentiment gauge is at 41. It was at 79 13 months ago. Which means a lot of optimism has been wrung out of the market. That’s positive for the market from a contrarian point of view. Another positive: The Investors Intelligence Bulls/Bears poll of market writers is also getting more bullish from a contrarian point of view with bulls at 29% and bears at 34%. That’s a 5% negative spread compared to a positive spread in the mid-40s a year ago. A negative spread historically has signaled a market bounce.
A note of caution. We continue to believe base on historical data that the market will be very volatile and highly risky for 2019.
The Ned Davis Research Composite Model for the U.S. Stock Market is based on an equal weighting of 50% of U.S. stock market internal and 50% external indicators. The NDR model has proven to be an important tool for identifying periods of outperformance and underperformance for the stock market. While the top chart plots the S&P 500 Index, the bottom chart plots the NDR composite score, which has moved down below 55. That represents bearish conditions and negative returns for the market. Composite readings above 70 represent bullish conditions and readings between 55 and 70 represent neutral conditions.
AS NDR explains: “By combining multiple indicators which historically have been shown to add value in broad market investment decisions, we can objectively assess the weight of the evidence and generate a summary broad market recommendation.”
It is important to note, as shown in the two boxes below the chart, that historically there have major negative market returns when the NDR Composite has been below 55. The boxes also illustrate the accuracy of the model in bullish and neutral conditions.
Here’s the composition of the internal and external indicators.
Internal Composite Indicators are tape-based (i.e., price-driven) indicators and include:
• Big Mo Multi-Cap Tape (DAVIS250A)
• Moving Average Slope (S61)
• Deviation from Trend Slope (S62)
• Deviation from Trend Reversals (S221)
• Momentum Reversals (S222)
• Net New 30-Day High Reversals (S223)
External Composite Indicators are non-price indicators and include:
We use investment sentiment as contrarian indicators because historically investors tend to be terrible at market timing, buying nearer tops and selling nearer bottoms. So for practically all of 2018 as the markets cascaded down, investors remained unduly optimistic. Now they are finally showing signs of fear, which could be part of a bottoming process.
Short-term investor sentiment this week showed growing fear. The CNN Fear/Greed index moved down to 4. The Ned Davis Research short-term sentiment indicator fell to 6. Meanwhile, the NDR intermediate sentiment indicator also showed increased fear, moving from 58 to 41.
The most recent short-term sentiment gauges are indicating investors have turned very fearful about market conditions, with the CNN Fear/Greed index at 7 and the Ned Davis Research short-term indicator at 15. From a contrarian point of view this is very bullish for equity markets over the next four to six weeks since historically investors are usually wrong about market direction.
Intermediate term indicators are leaning toward the bullish camp for the markets over the next six to nine months but they are not as outright positive as the short-term indicators. The Investors Intelligence poll of sentiment of market newsletter writers has bearish sentiment unchanged at 21% and bullish sentiment retreating to 39%. Bearish sentiment for this poll needs to move into the upper 30s before I could feel more positive that an intermediate bull market is ahead. Meanwhile, the intermediate NDR moved down to 50, another positive signs for the markets. But, based on historical trends, it should be at 40 to be really signaling an intermediate market bounce.
In the spirit of a picture is worth a thousand words, this week we leave you with a fascinating chart showing the changes in the yield curve from 1990-2018.
It’s truly mesmerizing.
Click on the image to view the animated data visualization chart.
Recently, the yield curve has flattened out as interest rates have risen but the curve has shifted more dramatically due to changes in short-term bonds. Of course, rates increased from an artificially low starting point. While an inverted curve has correctly forecasted prior recessions, plenty of fiscal stimulus has been pumped into the economy in the form of tax cuts. Consumer confidence has also surged. But, so have debt levels. Real incomes are stagnant. The Federal Reserve is shrinking its balance sheet.
So, while the circumstances today do not resemble the past, it probably won’t be different this time. Just look at the stock market. Small cap stocks are in a bear market. Hardly anyone noticed. Rougher times are likely ahead.