Weekly Update: The Fear of Losing vs The Fear of Losing Out

The market really wants to eclipse its May 2015 high, but (per the chart below) traders just can't seem to bring themselves to pay quite that much for the shares of stocks that comprise the Dow Jones Industrial Average. Not when they fear that emotion-driven players would sell on the next Fed rate hike, or, scarier yet, when the prospects for Great Britain's citizens voting themselves out of the EU (they call it "Brexit") are --- according to the polls --- tilting toward that end.   click each chart, then click again, to enlarge...



Well, after this week's Fed meeting announcement and dovish Janet Yellen's press conference, Thursday's message from the no longer hawkish St. Louis Fed President James Bullard, and the probabilities derived from Fed funds futures trading, the odds of more than maybe one rate hike this year just careened off the proverbial cliff.

So, for the moment anyway, the Fed headwind appears to be nothing more than a pleasant breeze.

But what about Brexit? If you believe the polls it's very much in the cards---and if you believe market signals, it could get ugly. However, if you believe the betting line, hedge fund managers, and the majority of pundits, the odds are pretty slim. If you believe me, you'll believe that a year from now the outcome of next Thursday's vote (whatever it may be) will not remotely be the topic du jour.

Ah then, so after the Brexit dust settles --- and since the Fed has turned off the fan --- traders should have little trouble pushing the market to new heights and beyond! Right? Well, I dunno...

We have to assume that the above (the Fed off the table and Brexit not being a long-term problem) is not some great revelation of yours truly. We have to assume that the above entirely credible narrative isn't lost on traders and investors at large --- I assure you it's not! So why then is it --- per the following --- that the uncertainty surrounding the market remains palpable?

Here's a look at the most cited sentiment index out there; a survey performed weekly by the American Association of Individual Investors:



I.e., individual investors are not presently feeling all that positive about stocks --- not at all!

And, per the Bank of America Merrill Lynch Fund Manager Survey (HT Fat Pitch Blog), nor are mutual fund managers. They're presently holding very large cash positions and are unusually underweight stocks:



I.e., their risk appetite (per their equity allocation and cash levels) is exceptionally low:



Funny thing is, stocks tend to do really well following periods of really low sentiment:



Really funny thing is, the more pessimistic the average investor is, the more optimistic you and me ought to be. Per below (HT Bespoke Investment Group), when bullishness is at its lows, the market tends to move higher over the ensuing year. And, conversely, when sentiment is at its highs, the market tends to trade lower:



So why would that be? Well, two things: One, when nobody thinks stocks are the place to be (low bullish sentiment), nobody owns them --- everybody's cash-heavy. Therefore, when everybody's in cash there's plenty of fuel to stoke the market on the first spark of good news. And, conversely, when everybody thinks stocks are the place to be (high bullish sentiment), everybody owns them --- and there's little cash on the sideline. Therefore, when everybody's fully invested in stocks there'll potentially be huge selling pressure on the first spark of bad news, and there'll be very few, if any, cash-hoarding bargain hunters prepared to jump in and douse the flames.

The other way to look at it is in the context of fear --- or types of fear. When we're talking investing, or, more so, trading, we're talking two kinds of fear; the fear of losing and the fear of losing out. When folks are bearish, thinking that the market's going lower, they fear losing --- so they stay out of the market. When folks are bullish, thinking that the market's going higher, they fear losing out --- so they're all in. Given that emotion is forever a moving target, or, let's say, pendulum-like, we know that it tends to migrate to and fro between the polarities. Thus, as cloudy skies clear (as they always do) and the consensus emotion begins moving from the fear of losing toward the fear of losing out, folks must buy (pushing stock prices ever higher) if they're to quell their jitters. And, conversely, when clear skies cloud (as they always do) and the consensus emotion moves from the fear of losing out to the fear of losing, traders have to sell (pushing stock prices ever lower) if they're to calm their butterflies.

So, while I have just enlightened you on why sentiment indicators are important things to track, I haven't solved the mystery of why the presently palpable pessimism (fear of losing). Well, my best guesses are Brexit, various coming elections, mixed global economic prospects, rich stock valuations, dire signals sent by phenomenally low bond yields and many more bad-sounding things that I just can't think of at the moment (it's late Friday evening). I guess the good news is there couldn't have been a time in history where sentiment was this low without a whole lot of bad news inspiring it. Hmm...

Does this mean that I'm a raging contrarian bull promising a bountiful 2016? Nope, just pointing out that the stage is set. The timing of the next break higher is anyone's guess, and we could easily break lower --- and maybe add to our positions at cheaper prices --- in the meantime.

Good thing you and I are calm, patient, opportunistic, long-term investors!

Have a great weekend! I know you'll all be very busy fawning over your fathers, your fathers in law, your stepfathers, your stepfathers in law, your fathers' fathers, your stepfathers' fathers, and (to our youngest subscribers) your fathers' fathers' fathers and your stepfathers' fathers' fathers come Sunday. Don't want you forgetting anybody! :)

Marty