Wednesday, December 20, 2017

No Fear

Gradually, like the shifting sands in the desert, you are going from doubt and pessimism to acceptance and optimism.  It has taken over 8 years for the transformation of investor psychology.  The scars from 2008 are still there, but the rally has been so strong, so long, and without enough corrections to scare investors.  I remember back at the beginning of 2014 when there were doubts about the stock market going up without Fed QE.  I don't hear those doubts anymore.  Not many people are worried about the ECB tapering QE and the BOJ reducing their QE purchases.  There isn't even much concern about the Fed raising interest rates almost every quarter. 

A steadily rising, low volatility up trend will give investors confidence about stocks.  Rarely do the daily buyers and sellers care about valuation, its about what is going to happen in the next hour, the next day, the next week, the next month.  And it has been up, so they extrapolate the past 8 years into the next 8 years.  It's the monkey brain that humans have not completely evolved from which still lingers.  It's why you have recency bias, why so many people believe in fake news, and why hearing repeated proclamations about how strong the economy is from CNBC and financial social media makes investors believe it.  In fact, US GDP growth has been basically stuck in a narrow range around 2% since 2010. 

Now with the tax cuts about to be passed, the optimism is through the roof as analysts extrapolate all the after tax earnings growth in the coming years, forgetting that the new tax rates are not permanent.  The investor sentiment surveys, which I usually ignore, are at astronomical levels, which is something I cannot ignore.  The put/call ratios have been very low for the past 3 months.

I remember back in the late 1990s when No Fear bumper stickers and t-shirts were so popular.  It is no coincidence that it happened late in an economic expansion with a booming stock market.  It is something you would have never seen in 2008.  It feels like a similar mood now, as consumer confidence readings hit extreme highs, as credit card debt explodes higher, just like the late 90s. 

Unlike the 2015 top, which led to just a 15% correction in the SPX, the amount of froth and optimism is clearly greater this time around.  Once we top out in this uptrend, which I expect in 2018, what follows will be a bear market, not a correction.  Until then, I will play the short side conservatively in order to preserve capital for when the real profit potential arrives.

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