Bear-o-meter says risk is neutral

The Bear-o-meter is a compilation consisting of of the some of the more important factors in determining the relative tradeoff between risk and reward on the US broad markets. The indicators fall into these 6 catagories:

• Trend
• Breadth
• Breadth-Momentum
• Sentiment
• Seasonality
• Value

A score of 0-8 is derived from 11 indicators falling into those categories. Some scores weight more heavily than others. At the end of the day, a high score indicates a lower risk environment for stocks, and a lower score indicates more risk. Its all relative. I’ve said it before, and will say it again; there is always the potential to make money or lose money on the market ….at any time. There are no absolutes, no sure things when it comes to stock market returns.

Having said that, I like trading with the odds. As such, when we see a low score on the Bear-o-meter, we at ValueTrend tend to reduce exposure to risk via raising cash and lowering beta.

Currently, the Bear-o-meter reads neutral at 4/8. That’s about as “right down the middle” as its gonna get! This suggests that conditions are normal. Its not time to back the truck up and buy high risk stocks, but its not time to start selling out of your positions either.

It should be noted that the Bear-o-meter spends more time between 3-5 (neutral environment) than at the other extremes. That makes sense, doesn’t it? All things being equal, market risk is balanced under most conditions. How often do you get unique opportunities to buy stocks in a low risk environment? March 2020, December 2018 are examples of these rare instances. You need capitulation fearful washouts to see super high scores on the Bear-o-meter. Conversely, how often do you see irrationally risky market environments where you should aggressively sell stocks and reduce beta? While I haven’t seen a “0” score in some time, I did see a “2” score in August of 2020. That signal did signal the end of the FAANG and stay-inside stock era, and the new rotation into value and reflation stocks. You can do a search on this blog to see the Bear-o-meter readings. I take one every month.

This month we saw the Bear-o-meter move down from a bullish score of “6” on March 3, 2020, to the current neutral reading of “4”. I took the reading this weekend – using the data from Friday’s close. So….Where did the indicator lose the two points?

One point was lost on the % of S&P 500 stocks above their 50 day SMA’s. The chart below shows us that the market has “too many” stocks ahead of their 50-day moving averages. This indicates that breadth-momentum is “too” positive. Too many stocks are enjoying the god life. In an irrational market, as money piles in it works its way into lower quality stocks as market participants desperately buy just about anything to participate. This indicator tells us that may be the case right now. Note that this situation isn’t rare–there are many movements where we get an abundance of stocks over their 50-day MA’s. So its a point against the indicator, but never something to be traded on alone.

The other indicator suggesting an unhealthy taste for risk by market participants is the Put/Call ratio. At 0.72, it falls below my line of “complacency”. In a neutral environment, the put/call ratio is just a little below 1, meaning that there is a lesser bias towards buying calls vs. puts. When the ratio falls below 0.75, it tells us that for every one hundred calls bought, there are only 75 puts. Market participants feel that buying the protection of a put option is unnecceary. Markets don’t have much chance of going down, so why bother hedging? Here’s the problem with a low put/call reading: Bad things happen, as the saying goes..”just when you least expect it…”

Conclusion

Overall, markets remain fairly evenly split between risk and reward. Trend indicators (moving averages) are bullish. Seasonality is good – April is historically a great month for markets. Cumulative breadth is excellent, as are most other breadth indicators. Beyond valuation and the two negative indicators noted above, its mostly business as usual for the markets right now. My only word of caution is that a change from “6” to “4” suggests a trend of growing risk. In May, the seasonal rating will reduce the Bear-o-meter’s positive points. If all other factors remain the same, we may see a negative reading in May. But, lets not draw conclusions ahead of the actual reading. For now, its likely best to stay fully invested….. but keep an eye on the puck. A neutral reading is not a raging bullish one. Its a ying-and-yang risk/reward environment. Anything can change.

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Last week’s video update: here

March performance numbers for ValueTrend: here