Last Thursday was a milestone for the stock markets. The Dow Jones Industrial Average, the Nasdaq and the S&P 500 each hit all-time highs on the same day (Thursday) – the first time that’s happened in this millennium. In fact, the last time it happened was on New Year’s Eve, 1999. Many investors will undoubtedly find reason for caution in this milestone. After all, stocks have come a long way in a relatively short period of time. This is especially true given the multiple risk factors we are facing at the moment, including the impending removal unprecedented monetary stimulus; an uncertain presidential election outcome; relatively high stock valuations; weak global growth; and continued weak economic data in the US, to include 1% GDP growth over the past three quarters as well as falling corporate earnings. Given this backdrop, many are justifiably wondering how we can be hovering at all-time highs.
But Wall Street Journal blogger Ben Eisen has a different take. In a posting on the newspaper’s web site yesterday, Eisen wrote that “between 1983 and 1999, the triple record happened 148 times. The average S&P return 12 months later was 12%, well above the overall average of 9.5%, according to LPL Financial.” Essentially what Eisen is saying is that market momentum can be (and more often than not is) more powerful than the other factors that affect stock prices. You’ve probably heard me and others refer to momentum investing by using old saws such as “the trend is your friend” or “the market climbs a wall of worry.” However you want to put it, a strategy of holding your nose and following the herd can very often work out…at least for a while. So while some see the milestone of a triple-index record as a harbinger of an impending market correction, others interpret the milestone as a precursor to more gains ahead. Depends on who you ask.
Another market harbinger that professional investors like to track is the CBOE Volatility Index, more commonly known as the “VIX” or the “fear index.” According to the Chicago Board Options Exchange (CBOE) web site, “The CBOE Volatility Index is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.” For our purposes here, it’s not important to know the details of how the VIX is calculated. Suffice it to say that the VIX is a measure of the amount of fear in the market. When fears of a market downturn increase, the VIX increases (and vice versa). And because the VIX generally spikes higher as the market is selling off, investors can buy the VIX (or securities that track the VIX) in order to gain some portfolio insurance against a sudden market downturn.
Puzzling to many, the VIX is currently trading at very close to its lows over the past year. At its current level of 12.7, it is also well below its average of 19.8 since 1990. Most people would assume that’s a good thing because it shows that there isn’t a lot of fear out there. But paradoxically, many market technicians interpret the low level for the VIX as a sign of trouble ahead because it reflects a high degree of investor complacency. Again, the data depend on who’s interpreting it. Bullish for some, bearish for others.
Still another gauge of market direction is the amount of shares that are traded across the entire market in any given day, commonly referred to as “trading volume.” One reason market technicians track trading volumes is because a relative dearth of trading can sometimes be another indicator of investor complacency. If volumes are high and stocks are rising, this is a positive sign of conviction by investors. If volumes are high and stocks are falling, this is obviously a sign that investors have become fearful, many times too fearful. But if volumes are low and stocks continue to drift higher into record territory, it’s hard to attribute the gains to investor conviction. Rather, the lack of enthusiasm to participate in the gains can be a sign that the market is tired and that the near-term upside has been exhausted. As it so happens, stock trading volumes have been pretty light over the past few weeks, even as we’ve reached new highs. Most traders will attribute the weak trading volumes to the fact that it’s August, and trading activity falls in the late summer. True, but still others say that if investors had more conviction the volumes would increase. Depends who you ask.
Finally, investor sentiment is many times used as an indicator for the markets. Let’s face it, this bull market is long in the tooth by any metric. In fact, the 7+ year bull market is now the second-longest on record. The big gains we’ve seen over this bull market have caused many investors (including hugely successful professionals managers like Stan Druckenmiller, George Soros, Carl Icahn, Jeff Gundlach, and Bill Gross) to say now is the time to take some gains. But investor sentiment itself is used as a contrarian indicator as well. And according to Nir Kaissar of Bloomberg, “it’s not just the bigwigs who are concerned: Eaton Vance’s Advisor Top-of-Mind Index, a quarterly survey of more than 1,000 financial advisors, found that respondents are more worried about managing volatility than anything else – and they’re more worried about it than at any point since the index began in 2014.” Negative sentiment can be further confirmed by looking at the sizable redemptions of equity mutual funds by retail investors this year. In fact, an August 12th Wall Street Journal article by Corrie Driebusch and Aaron Kuriloff said, “As of Thursday, the American Association of Individual Investors’ weekly sentiment survey showed 31% of individual investors said they were bullish.” That’s a pretty low number. You would assume that weak investor sentiment is a bad sign, but is it? Most pros will tell you that the more negative sentiment gets, the better the outlook for stocks. The rationale is that if all the naysayers have already sold their stocks, there is nobody left to sell and take down the markets in the process. Makes sense, right? Again, depends on who you ask.
So should we follow the herd or not follow the herd? If you got my point that all these different indicators can become very confusing, you were paying attention. We’ve stated our opinion for quite a while now that the market’s strength reflects a “Goldilocks” economic environment which is neither too hot to force the Fed to hike rates nor too cold for investors to worry about an economic recession. But whatever the reason for the continued strength, I think it’s fairly safe to say that very few pundits had anticipated the market returns we’ve enjoyed this year given the difficult backdrop. And the ambiguous and often conflicting indicators that the pros use to predict the future direction of the market have been completely undependable. For our part at Farr, Miller & Washington, we have learned through many years of experience that trying to time the markets is an exercise in futility. We suspect you knew where we were going with this one: As investors, we will remain invested for the long term, and we’ll leave it to the speculators to try and time the markets.