The Triumph Of Greed Over Fear
Williams Market Analytics, LLC
Long/short equity, momentum, newsletter provider, registered investment advisor
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 forBrown 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:stock to riskier small cap stocks comprising the Russell 2000 (NYSEARCA:is another decent, market-based metric of greed and fear. We calculated that 89% of the S&P 500 (NYSEARCA:
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