Long time readers of this blog know that I report on the relative risk/reward tradeoff on US markets at the beginning of each month via my Bear-o-meter compilation. This simple to understand indicator combines 11 factors that I have been using over many years of my career. I use it to understand the current tradeoff between potential upside vs. downside on the market. The Bear-o-meter presents a scale of 0-8, where 0 is high risk relative to return potential, and 8 is low risk relative to return potential.
As I always point out – markets present BOTH upside potential AND downside risk at ALL TIMES. Under normal conditions, the Bear-o-meter reads somewhere in the middle of that tradeoff- which is illustrated in that scale via a reading between 3-5. However, that tradeoff can be skewed towards one side of the equation or the other at times. We can measure that tradeoff by looking at the markets trend, its breadth, its valuations, current seasonal influences, and market risk appetite. To put it simply, an overbought, overvalued, over-optimistic market is more risky – and that risk is illustrated via a reading of 0-2 on the Bear-o-meter. An oversold, undervalued, pessimistic market presents a less risky investment climate, which can be numerically illustrated on the Bear-o-meter as a reading of 6-8. Again, those conditions are considered extreme, against the typical balanced market of risk/reward conditions.
The Bear-o-meter just signaled its first high-risk reading since August of 2020. It should be pointed out that the Bear-o-meter was quite accurate regarding its risk assessment that month. Turn the clock back, if you will, and recall the concentrated (narrow) breadth of the market at that time. Investors focused on just a dozen or so “stay-inside” and technology/ FAANG names. The Bear-o-meter was dead-on with its high risk assessment of “2”. The SPX was near 3600 at the time of the reading. It fell to 3400, and did not surpass 3600 until 3 months later in late November. The NASDAQ followed the same pattern, moving drastically more – from 12,000 down to 10,500 – and not recovering until late November.
Even more significant was the near-perfect low-risk reading the first few days of November (reported Nov. 2nd on this blog) when the SPX was right at the bottom of its trading range near 3400.
This backdrop brings us to today. As of June 2nd, 2021, the Bear-o-meter is presenting a high-risk reading of “2” – similar to the reading seen in August of 2020. In fact, the Bear-o-meter has been declining one point a month since March of this year, when its last reading of a “bullish” 6 was taken. To me, this means one thing: raise cash and lower beta. A high risk reading on the Bear-o-meter does not imply that the market cannot rise from here. It does imply that the market is presenting far greater risk than it has in while. While it is true that “Trend Trumps All” – it is also true that the greatest truism proclaimed by John Templeton was to “Buy when others are despondently selling, and sell when others are greedily buying”
The big changes we have witnessed on the Bear-o-meter fall into the investor sentiment and breadth momentum readings. Effectively, this means that investors are overconfident, and markets have expanded on that confidence too quickly. Templeton’s suggestion of “selling when others are greedily buying” is ringing in my ears when I look at the indicators making up breadth momentum and investor confidence in the Bear-o-meter. Below are two of the indicators I am looking at. Note their relative levels to where I mark the “risk” levels. They are: the Put/Call ratio sentiment reading, and the New High/New Low breadth momentum reading. It might be noted that the New high/low indicator is sitting at the highest level I have on my records – certainly above anything seen in the last 20 years (chart below, note the spike on the right side of the chart).
Hi Keith … any possible MARKET exceptions that might weather any coming storm, such as Energy/TSX? Vaccines into more arms and economic recovery, the diminishing oil supply story seems to have some legs. I’ve been taking some profits after getting invested early after the oils crashed (thank you for your timely past articles) but the $100 oil guys, might they be onto something?
Bob–we are BIG believers in an $80-85 barrel of WTI-probably before year end -but its overbought right now (actually – materials are crazy overbought, oil is not as bad, but still…). I think its good to hold div paying oil stocks (we do!) –we also hold 2 pipelines. But we did pare a bit off, with the intention of re-buying if an opportunity (selloff) appears.
Hi Keith, thank-you so much for sharing this important update regarding your bear-o-meter. In general, when you get this type of high risk reading, do you think going to a cash position of 20% in a income based portfolio is appropriate.
We went to about 15% on the signal yesterday (Wednesday) –we were 12% and sold another chunk (NASDAQ-sensitive position due to our belief that that is the most vulnerable index) –can’t tell you what is appropriate for you, as you have your own methodology and your own “beta”–if you are high beta, more cash makes sense, but if you are low beta (dividend low vol stocks) then less cash is ok.
Again–this type of decision is a probability move. We don’t have any assurance that the market will correct, and we will underperform if the Bear-o-meter is wrong. It could keep going up. To us, its just playing the odds in the great gambling machine that is the market!
Do you have any indication, how much the market may go down?
Sam–I am a big believer that bull markets typically correct close to the 200 day SMA. That lies just under 3800 right now for the SPX. I did a blog a while ago showing that most of the time, the 200 day is either touched, or tested within 3% or so. Occasionally you get a break below, but my expectation would be for the SPX to land between 3800-4000.
Hi Keith, can you tell me what causes treasury yields to rise in the U.S. is there a way to predict in advance of this happening?
Krista–there of course can be technical reasons for anything to rise (overbought, oversold conditions or trends)–but the fundamental reasons usually lie in the dollar and inflation. Strong dollar means the country has stronger economy, and a “safe haven” status which makes yields fall ( a strong currency means you wont lose out by owning that countries currency so international investors are happy to buy the countries bonds – the bond yield can be lower and still attract investors).
Right now, there could be a threat of rising inflation…not just in the nearterm…If that is the case (IMO it is)… Higher inflation means the market anticipates higher interest rates in the future as governments move to squash inflation.