The Stock Market is Entering an Elevated Risk Level
At its lowest point so far on October 12th, the S&P 500 stock index was down -25% for the year in 2022.
Since October 12th, the stock index has gained 10%, which is common in prolonged bear markets.
In bear markets, we see many swings up and down as the market cycles through periods of investors' fear of losing more money and fear of missing out.
I've long observed investors oscillate between the fear of losing money if they're holding on to losing stocks and the fear of missing out if they're in cash as the stock market trends up.
I've been monitoring a suite of indicators for over 25 years now, so I've developed some useful intuition about risk levels and inflection points.
It's the kind of intuition from observations we've been unable to quantify with programs, machine learning, or artificial intelligence. Much like our machines can't tell the difference between a cat and a dog.
While many of my risk measures are proprietary, they often correspond to other publically known measures I like to use for illustration.
Below is the trend line version of the Fear & Greed Index. As you can see, the seven unique investor sentiment indicators that drive the Fear & Greed Index oscillate between Extreme Fear and Extreme Greed. We consider it extreme because, eventually, the crowd gets it wrong at extreme levels of bullishness and bearishness.
This composite of seven market-driven indicators is now entering the Extreme Greed level, which is bearish. Once the crowd is already bullish and taking on more and more risk, their desire to buy eventually slows down or reverses.
Another risk barometer is the S&P 500 Bullish Percent, which shows the percent of S&P 500 stocks in an uptrend as measured by a Point & Figure buy signal. We like to see it rise, showing broadening participation in the uptrend, but it eventually enters the danger zone, suggesting a higher risk of reversal.
It's doing it now.
While 74% of the stocks in the S&P 500 index trending up with buy signals is bullish, once it gets to these higher levels, it becomes bearish, a sign buying demand may be nearing exhaustion.
When I see these elevated levels, I may keep following the trend, but I know to be on alert for a trend reversal.
It's a warning shot across the bow.
Another way to measure investor sentiment is through polls and surveys like the AAII and Investors Intelligence Advisor Sentiment.
Looking at the Investors Intelligence Advisors Sentiment, bullish advisors once again outnumber the bears, and while advisor bullishness is a good thing in the early stage of an uptrend, it eventually reaches an extreme, and that suggests they may already be fully invested.
Supply and demand drive the price in all things, so these are simply measures of the shares for sale and the shares buyers want.
If investor enthusiasm to buy continues to overwhelm the desire to sell, prices keep trending up.
When the desire to buy is no longer dominant over the desire to sell, prices fall far enough to attract renewed enthusiasm to buy.
We can measure these things quantitatively and be prepared for a change in trend.
We're entering a point in the stock market trend that could be an inflection point. My market risk indicators are elevated, suggesting DEFENSE, but they're imperfect. In bear markets, we'll see lots of whipsaws and head fakes, and OVERBOUGHT and EXTENDED can continue.
But right now, what I'm seeing suggests the more likely scenario is a pause or reverse in the uptrend, which will then be resolved when we see if buyers or sellers are more dominant.
#SemperGumby is a phrase used by U.S. Marines, meaning "always flexible."
We have very little exposure on the long side of stocks today, but we'll see how it all unfolds from here.
I hope this helps! If you need help or have any questions, don't hesitate to contact us!
Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.