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Euphoria in the market is literally off the charts.
Here’s the Panic / Euphoria model from Citi below.
Not much else needs to be said other than it’s time to work into hedges.
The team at SentimenTrader tried their hand at recreating the Citi model based on their understanding of the inputs that go into it.
While SentimenTrader’s version isn’t as extreme as the original Citi model, the result is close. When the SentimenTrader proxy is above 1.0 (Euphoria), which happens about 14% of the time, the annualized returns for the S&P 500 are -3.7%. Conversely when the model is below 0 (Panic), the market returns 21.4% annualized.
More importantly, based on this version, the market sits at the third most extreme level of euphoria in the last 30 years.
Market Euphoria is Literally off the ChartFurthermore, SentimenTrader provides mode detail on the specific signals and the future returns.
Market Euphoria is Literally off the Chart
Median returns tend to be negative across the board. Only 2011 was positive a year later, and barely so. This is even more reason to get active in hedging.
Active Alts has partnered with SentimenTrader to create proprietary signals that help inform the exposure in a long / short strategy. To learn more about how these models can help you mitigate risks in the market, book call with Brad.
The froth in market sentiment has backed off a bit but still in the danger zone. Stock market bulls still top 60%, and while bears have inched up a bit, the spread between the two exceeds nearly 43%.
As the chart below from Investors Intelligence shows, the bull/bear spread is still in the upper end of the range over recent history. Proceed with caution. We are still in the danger zone.
As we noted in the most recent Chart of the Week, there’s a fascinating piece from GMO published December 8, 2020 that talks about the bloodbath in value investing.
If you’re not familiar with GMO they manage over $60 billion. And the “G” in GMO refers to Jeremy Grantham who conducted groundbreaking work on quality metrics in the 1970’s.
To recap the gory details, here’s a synopsis from their report:
“After more than a decade of disappointing performance, Value stocks just experienced their worst 12-month performance in history. This has left these stocks trading at some of the cheapest levels relative to the market we have ever seen. This cheapness is robust to a variety of challenges that skeptics may raise, and this is true broadly across all major equity regions. An analysis of the sources of returns for Value since 2007 shows that more than 100% of Value’s underperformance is due to falling relative valuations, confirming that under the surface the Value premium actually still exists. If Value were to continue trading at current spreads to the market and experienced the same relative fundamental performance as it has over the past 14 years, it would beat the market. The flip side of the extraordinary cheapness of Value is the expensiveness of Growth: we believe Growth stocks have entered a bubble similar to the one in 2000. While we are not sure what the catalyst will be for the deflation of the Growth bubble and the recovery for Value, there are a number of plausible candidates for one, not least the eventual recovery of the global economy over the next 12-18 months as the pandemic recedes. We believe the outlook for Value is exceedingly bright from here, particularly in a long/short framework, which can profit from Value’s outperformance in both rising and falling markets.”
Even if we are entering another bubble in growth stocks, plenty of opportunity exists in the market. Closing the massive spread between value and the market will create huge opportunities for alpha in the coming years.
What’s more is that not all value stocks are the same. Some stocks are cheap for a reason. In our own work, we saw value, combined with quality and momentum, perform well in 2020. And, we agree that long / short is poised to perform well going forward.
Active Alts operates two strategies to navigate through all market conditions.
The long-only, Active Alts Focused Momentum Strategy was up 79.60% in 2020. What’s more, 2020’s performance was achieved with an average exposure of 74.87%.
In December, the strategy turned in a performance of 22.16%, with an average exposure of 55.09%.
Quality, momentum, value, and risk/reward. Those are the factors, when combined into one cohesive approach, are the engine that powers the Active Alts Focused Momentum Strategy.
The Active Alts Long / Short finished 2020 up 25.91%
That same GMO report, published December 8, 2020, is decidedly bullish on the long /short space in the future. The historical spread between value and the market is likely to revert to the mean.
This bodes well for tactical stock pickers.
Want to know more about the Active Alts Focused Momentum Strategy and the Active Alts SentmenTrader Long / Short Strategy?
Market sentiment remains very bullish. Too bullish. The weekly bulls and bears poll conducted by Market Intelligence shows 63.6% bulls and 17.2% bears. That’s only a slight change in bulls from the week before when they hit 64.4%.
Too many bulls by itself isn’t a contrary indicator. Yes, those folks are leaning the wrong way. But, what goes up can go up even more before the tide turns.
One chink in the armor suggests the tide might be turning.
Until now, the breadth of the market has been strong in this rally. That changed a bit on Wednesday. The S&P 500 Index made a new 52-week high (no news there), but there were 75 more declining issues than advancing issues in the index for the day.
Here are some stats courtesy of SentimenTrader when this condition has occurred in the past.
When this situation occurs, returns are historically negative one month out. About 53% of the time, the market suffers a loss. Three months later, there’s typically an excellent recovery. On average, the market is 3.9% higher. However, there have been some significant declines, such as the 15.5% loss in July 1998.
One day does not make a trend. However, it is a warning sign. It’s a sign to be on guard. With so many investors leaning in the bullish direction, now is the time to be paying close attention. It’s not a time to be complacent.
The Active Alts SentimenTrader Long / Short strategy is anything but complacent. The strategy utilizes decades of real-world experience and research with a sharp focus on risk management. Give Brad a call to learn more about how you can be better positioned in your portfolio in 2012 and beyond.
As you can see by the purple dot on the far-right hand side of the chart, we have now hit Internet Bubble levels of Euphoria.
We know how that turned out.
What really matters is not where we are but what it means for the future.
This chart proves very helpful in plotting that course.
The shaded grey area highlights the 12-month forward returns. It’s especially telling in super euphoric periods. Those returns are negative. They’re nasty.
Combine this with other indicators such as Buffet’s favorite market indicator, which we highlighted in the Chart of the Week, and it’s not a big stretch of the imagination to have a historic swing the other way.
When will it happen? Who knows? Only liars can predict the future.
We do know that human nature never changes. With sentiment, valuations, and other factors positioned the way they are right now, buckle up for 2021. It’s going to be epic.
How could you capitalize on this for your own portfolio?
Give Brad a call. The Active Alts SentimenTrader Long / Short Strategy combined decades of experience and world class research in a model to capitalize on any market environment.
As Alexander Hamilton once said, “the masses are asses.” He probably wasn’t referring to the collective wisdom of investors, but it could easily apply to this group.
As a group, investors are terrible at projecting forward market returns.
When investors are leaning too far bullish or bearish, it creates great risk / reward opportunities.
We love extremes.
Right now, we are at an extreme in bullishness.
Newsletter sentiment is currently 60% bullish and 19% bearish. We are projecting that the bullish number could tick up another 2-3% next week as the 60% level was hit before the vaccine announcement earlier this week.
These levels are rare.
A bullish level above 60% happens about 6.4% of the time going back 50 years. A spread of 40% happens 8.8% of the time. A combination of the two? Just 3.8%.
As we all know, we are not in normal times. It’s certainly not normal in terms of market sentiment.
When this situation occurs, market returns are just 0.4% three months out. Of course, that doesn’t mean they are flat. It could mean a major ass kicking and then as sentiment normalizes a market bounce occurs to claw back to even.
Sentiment could be right this time. But, probably not. Markets change. Human nature stays the same.
Looking back at recent history over the last 15 years, every major correction has been preceded by this big spread in bullish / bearish sentiment.
Hamilton was right. The masses are asses.
It’s also important to note that the average investor is overly bullish too. We do not put as much weight into this indicator as we do newsletter writers. But we are also well outside the norm.
Here’s some quick stats on where we are.
Bulls are 56%. That’s in the top decile of the last 33 years. It’s in the top 6 since the March, 2009 low. We should point out that March, 2009 was the most bearish period ever. Right before a huge bull market run.
The bull to bear spread is 31%. That’s in the top give in history.
Both of these levels are the highest since January 2018.
Want to know more about how sentiment can impact your portfolio?
Why don’t you give Brad a call?Brad’s Active Alts SentimenTrader Long/Short Strategy combines several decades of experience and research and actively positions the portfolio to take maximum advantage of market extremes. In both directions.