“Be fearful when others are greedy, and greedy when others are fearful.” – Warren Buffett, legendary investor
Recent volatility in the stock market has served as a barometer of investor sentiment and in my analysis only further confirms my recent market call, that regardless of near term price action, long-term investors should now be fearful of stocks. Most investors far too often end up buying high, selling low and realizing disappointing returns. A case in point is the current bull market that began in 2009. For the first few years, when prices were considerably lower, investors were much more fearful than now and inclined to sell or shun stocks. Of course that is what makes for a stock market bottom and the start of a new bull market–the investment herd selling their stocks, when things are at their worst. And the financial media only serves to exacerbate matters. Pushing stories of risks around depressions, financial calamity and double-dip recessions, when the market was bottoming. But that was actually the best time to be greedy. Now prices are much higher. And the investment herd is greedy to get a piece of stock market gains, while the financial media is favoring stories about how pull backs are buying opportunities. In my opinion, now is the time to be fearful and instead use rallies as selling opportunities… that is if you’re goal is to go contrary to the herd by buying low and selling high.
Unwilling to yet call a bear market, I have nevertheless become increasingly negative on this bull market. But despite a rough January, the stock market, as measured by the S&P 500, remains above its 125-day moving average—a level it has held for over a year. As such it would still be premature to call the current bull market over. But it’s not too early to examine why a meaningful move down with a breach of important technical levels, such as the 125-day, will be a reason to adopt a defensive posture, rather than “buy the dip” as so many are already advocating. In the spirit of my first “A Scary Looking Market” post I’ve included some new charts that argue against many of the currently popular bullish arguments. There is good reason to believe that optimism for the ability of the Federal Reserve through monetary policy to engineer strong economic growth is misplaced. Also unlikely to be realized is the hope that stock price multiples will grow further in a Great Rotation of investors moving from cash and bonds into stocks.
As the stock market makes new highs, there are many reasons to worry that the fall could be particularly hard when it comes. I’m no permabear and have not been constantly arguing a bear market is around the corner. Even if I haven’t been the biggest cheerleader of stocks I have been an advocate. For example in August of 2011 I wrote about how, despite negatives, stocks were the best investment options available to most and in my February post this year I argued that despite rising risks investors should continue to hold stocks and a decline was unlikely to transpire until 2014. At the same time, starting in May of this year, as the stock market kept making new highs, I began to argue that risks in 2013 were rising and investors should use the strength to raise cash levels and sell some stocks, particularly money involving a low risk threshold and time horizon. As I look at where the stock market stands at the end of the year, I continue to believe the risks of a bear market being sooner rather than later have only grown.
Investors should be nervous about the stock market, but they’re not, and that’s even more reason to be worried. Retail investors tend to sell low and buy high, and throughout the current bull market they have been mostly negative on stocks and missed out on much of the gains. Now after years of strong returns they’re finally turning positive on stocks. That is not unusual. Investors react to performance. At stock market bottoms prolonged market losses make them fearful, and at market tops years of gains make them greedy for more at just the wrong time. Some measures show investor sentiment has not been this positive since the last stock market top, and if history is repeating retail investors are turning optimistic on the stock market just in time for the next bear market.