“Greed, for lack of a better word, is good” – Gordon Gekko, Wall Street (1987)
With all due respect to Gordon Gekko, when it comes to investing it is not greed but fear that is good. Fear creates opportunity and a favorable balance between risk and reward. Greed inevitably leads to poor decision making and chasing higher risk investments with little reward.
For the better part of the past year and a half, greed has been the dominant emotional state amongst investors. The “wall of worry” that had persisted throughout the early years of the bull market was torn down. In its place: greed and the strongest emotion of all, the fear of missing out.
As I wrote last December, investors had gone “all-in” on U.S. equities and were exceedingly optimistic about future returns. In the past, this has led to below average future returns which is indeed what we have seen through the first nine months of 2015.
But today, after the largest S&P 500 correction (12.5%) since 2011, the emotional landscape is shifting. Fear is emerging as investors have come to learn that U.S. equities are not risk-free.
- Bears outnumber Bulls in the Investors Intelligence survey for the first time since 2011.
- The ratio of puts (bearish bets) to calls (bullish bets) is at its highest level since 2012.
- Active Managers have reduced their net long equity exposure to 16%, down from 99% back in February.
- Fear in Emerging Markets such as Brazil is approaching historic levels, and has pushed prices back to their 2008 lows. We are told that there is not one good reason to invest in Brazil today which from a sentiment standpoint exactly what you want to hear.
This increasing fear is a good sign as forward returns are generally above average when investors turn exceedingly bearish. This is another way of saying that the short-term balance between risk and reward is improving for the first time in a while.
To be sure, this commentary is focused on the short-term, and the next few years are likely to be more challenging and volatile (click here for our research on Lumber and Gold as leading indicators of volatility) for the reasons I laid out back in March.
Nevertheless, we should all be encouraged to see increasing fear at lower prices today (they loved the S&P at 2130 and hate it at 1860). Fear, for lack of a better word, is good.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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