The smell of fear

“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude” John Templeton


Years ago Leslie Nelson did a movie called “Naked gun: The smell of fear”. If you like slapstick comedy, you may enjoy it.

Human beings, like most other mammals, are pre programmed to be able to identify fear. This, apparently, occurs through pheromones – picked up by our olfactory senses. There has been some academia written on the subject, as covered here. I wonder if this “pheromone” sensor we all posses is helping give us get the sense of the fear on the stock markets right now.  I don’t know about you guys, but I sense that there are some stressed investors out there.

Another way of detecting fear is to watch how the more emotional investors are reacting to the current market. You can measure this quantitatively. For example –  we can look at sentimentrader’ s “Smart money/ Dumb money” spread. I’ve posted their smart/dumb confidence spread chart here in the past. Below is the newest reading, which shows us we are clearly in the “buy” zone for that indicator. For the record, 61% of smart investors (pensions, commercial hedgers, etc) are confident. Only 26% of the dummies (retail investors, mutual fund buyers, small board lots etc) are confident. The smell of fear is high amongst the dumb investors. And that’s bullish.

Another sign of investor fear is the VIX. In fact, the nickname for this measurement of option premiums is “the fear index”. Doesn’t get much clearer than that, does it?

The VIX rises when premiums rise on options. Premiums rise because investors are pricing in a likelihood of greater price swings. I noted in my last Bear-o-meter report in early October that the VIX had dropped below 12.

That low score indicates a lack of fear (i.e. low option premiums—low volatility anticipated by options traders). The chart below shows us that the VIX recently spiked to almost 25, and is currently sitting just under 20. You will note that 20 is my first level of “overly pessimistic” emotions by market participants. And that is a bullish sign

One should not take one or two indicators as the go-ahead to execute a trade. However, there is mounting evidence that we are really, really close to a buying point. I’ll do a full Bear-o-meter report in a week or so. That will give us a bigger perspective and hopefully a better risk/reward signal if the coast is likely clear to buy. Until then, we should be anticipating that the current correction is nearing its point of climax. I would expect a buying opportunity is coming soon. Can you smell that opportunity?


  • Hi Keith,
    “However, there is mounting evidence that we are really, really close to a buying point. I’ll do a full Bear-o-meter report in a week or so.”

    What does ‘really really close mean?’ To me it hints of days, but you refer to the Bear-o-meter report in terms of weeks.

    My best guess to enter is when stocks pass and hold the highs of the 16th and 17th. Am I missing something?

    • Hi Sally–yes, it could be days when we see the washout bottom- although you have to call it as it happens–and to clarify your other question, I will do a Bear-o-meter report in a week or so–not in weeks, but likely Monday or mid-week next week. I want to see how things shake out before running the full spreadsheet. Also, the favorable seasonal period starts next week.

      Finally – everyone has their own style, but my view is that because we have not taken out the last low on the weekly S&P 500 chart (which lies around 2500-ish) and we are playing with the 200 day SMA–it is still just a correction, not a bear. As such, and assuming 2500 isn’t taken out, I could buy as it bounces – I will wait a few days for continued positive movement (note how during the complex bottom over the month of October so far- there has been no string of 3 positive days yet–hence, no buy signal). I will leg in, but I wont take forever to do so, assuming no breakdown after that initial 3 days of support.
      I’ll blog when I am buying. You always have to make up your own mind, but to me, this is opportunity that is awaiting. Interesting to see if todays selloff pulls back into the Oct. lows of around 2700. if so–and a bounce follows…could be a double bottom. We shall see.

  • To add to your blog, I look at the 52 week highs and lows each day for a quick and dirty look at market health. Stockcharts today shows an overall total 52 week high of just 18 for all the markets they survey vs. 1,159 for the low. And on the TSX, 3 on the 52 week high and 79 for the low.
    Wow! I have never seen such pessimistic numbers.

  • Hey Keith, I did some buying today, as I liked the recovery that we saw in today’s rally off the lows. We are heading into the best six months, which has averaged a 7.3% return during this six month period, plus dividends. Results are not quite so good, if the United States is in a recession, which we are not. I also shorted the maturity of my treasuries and high grade corporate bonds, since I am convinced that long term interest rates, are going to more or less, keep rising.

    Looking forward to giving you a good old fashion Floridian greeting at the Orlando Money Show next February, assuming that you can still make it. After all, who is going to take my place, to make sure you leave after your presentation, with all your cables for your portable computer.

    • Hey Tony–good job on the buy–yeah, you are close enough to the bottom methinks. I have not started yet, but I like a few up-days to confirm before buying. Buying higher misses out a bit, but is safer.
      I am booked to speak at the February Moneyshow on the Friday in Orlando. I’ll confirm in the New Year that I am still good to go. I will look forward to seeing you again–really like the facility there.


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