An Overvalued Market
The Bear-o-meter is a risk/reward measurement tool that I’ve been using since 2013. It’s a compilation of indicators falling under general classifications of:
- Breadth
- Value
- Trend
- Breadth momentum
- Sentiment
- Seasonality
As many of my regular readers know, the Bear-o-meter assigns risk on a scale of 0-8. A reading of 3 or under is considered a higher risk market. A reading of 3-5 is about “average” for a risk/reward trade-off. Anything 5+ is considered lower than average risk. Surprisingly, the Bear-o-meter reading as of today (Feb. 3 2021) was positive. It reads “6” today. This, in spite of a number of shorter termed momentum indicators that might suggest an overbought market.
Remember, the Bear-o-meter isn’t about market timing. It tries to assess the internal health of the market through factors like breadth and sentiment. Both risk and reward are always present in the stock market. By understanding that relationship, we can ascertain whether we should be more cautious, or more aggressive on an overall basis. We can’t use the Bear-o-meter to tell us when exactly to buy and sell. My favourite analogy is that of crossing a road. If you cross the road in the subdivision you live in, you likely won’t be hit by a car…although there is a small chance of that happening. Risk is low, potential reward (crossing safely) is high. Run across an 8-lane superhighway, and that risk increases. But it doesn’t mean you absolutely cannot get across without being hit by a car. The risk is high. The reward potential is lower on a relative basis.Had I taken a reading of the Bear-o-meter a week or two ago, we would have had an even higher score. The VIX hit 37 on January 28th. That was a bullish signal. Currently, it is neutral, as it sits near 25.
Conclusion
I do not doubt that markets are overvalued at this moment, and subject to some volatility. Sure, we could see a 5% or higher pullback. But the internal breadth and trend indicators trump all of the overbought noise I am seeing (for example, the SPX sits about 12% ahead of its 200 day SMA). Buy the dips.
ValueTrend Videos
Check out my weekly videos here. At the end of the week, I post a 10-minute video (to the point as I can make it) covering the blog topics presented over that week – but I try to add a few new charts and thoughts to those presented on the blogs. Here is the link to the video page.
ValueTrend performance
Click here to see the updated performance of our Equity Platform, our Aggressive Growth Strategy and our Income Platform. I’m happy to report that we are performing quite well in the current environment. Our mandate is to achieve lower risk returns (Equity and Income Platforms). By using technical trading strategies (like the Bear-o-meter!) we typically achieve that mandate during turbulent times. Volatile markets are our strength. I’m also happy to note that our Aggressive Strategy, which is now being tracked on the website, is performing well.
2 Comments
Please comment on the following thesis: In an uptrending or downtrending market, moving averages are better indicators of support and resistance compared to horizontal lines, whereas the reverse is true in consolidating patterns.
Thanks a lot for your educational blog and new videos!
Yes Andrew, this is absolutely correct. I have noted many times (including in my book Sideways https://www.amazon.ca/Sideways-Technical-Analysis-Profit-Uncertain/dp/1926645685) that moving averages are mostly useless within consolidation patterns. To your point–you trade the range in that case.