Moving From Risk Off to Risk On

While stocks seem to be noticed the most when there are major problems or
concerns in the world, this is really a result of something bigger. The mood of
the individuals and investors all around the world shifts between being
optimistic and pessimistic. This mood can be fickle. It oscillates between seeing
the glass as half full or half empty.

Global stock markets tend to rise and fall together, suggesting that the mood of
investors all over the world changes at the same time. It is like the tide that lifts all
boats and drops all boats. While the magnitude of the moves can vary, the trend is
almost always in the same direction.

When stocks fall, other risky assets fall too. When the mood changes to a
negative mood, crypto currencies can fluctuate wildly. Other major world
currencies usually fall as well as cash moves to the ultimate safe haven – the US
dollar. Commodity prices typically fall as well. For much of the last 40 years,
money has moved into the safety of government guaranteed bonds when investors
become risk averse. However, that has not always been the case this year and in
recent years when interest rates have been so low.

When concerns increase, or there has been too much optimism for too long,
there is basically a move away from riskier assets to safer assets. When pessimism
has existed long enough to get investor sentiment and the price of risky assets
back to a healthy level, there is a move from safer assets to riskier assets.
Therefore, one of the ways we can see how the mood of investors is shifting is to
look at how safer and riskier assets are acting. We can also see how far the
pendulum has swung to the pessimistic side by looking at oscillators to see how
oversold prices have been compared to other times when investors have been
worried.

I usually include the long-term oscillators but these are very long-term
oscillators that show major longer-term shifts. This oscillator is for the US$ Index
over the last 20 years. The green and red bars shows the value of the US$ Index.
This is the highest value since 2003. The oscillator has only been this high in
2015. This shows that there has been a huge move away from risk and into the
safety of the US$. The green arrow shows that this oscillator has reversed and is
now turning down. This indicates that there is a psychological shift causing
money to flow back into riskier assets. This shows that investors are becoming
more comfortable.

The chart below is the very long-term oscillator for the Volatility Index. Stock
market volatility has been unusually high for two years now. This is very rare.
However, over the last 20 years this oscillator has only been this high during the
Financial Crisis and during the first European Debt Crisis and the US Debt
Ceiling Crisis in 2011. The S&P 500 also fell 20% at that time. These very long-term
oscillators take longer to reverse than the long-term oscillators.

This is the very long-term oscillator for the S&P 500. It has not been this
oversold since the Financial Crisis in 2008/2009. It was also this low during the
2000-2003 bear market. In other words, this has been a very severe sell-off even
though the S&P 500 has declined less than it did from 2000-2003, less than half
as much as it did during the Financial Crisis and much less than it did in 2020.

The long-term oscillator for the S&P 500 is shown below (as opposed to the
very long-term oscillators shown above). The yellow arrow shows how it turned
up in March. That turned out to be a rare false signal. The green arrow shows that
it has now turned up from the fully oversold level as it did at market bottoms in
early 2019 and spring 2020.

This is the long-term oscillator for the Russell 2000 Index of 2000 US smaller
companies. The yellow arrow shows the rare false buy signal in March. It has
now turned up again, marked by the green arrow. The oscillator for the S&P 400
Index of 400 US mid-sized companies is also acting exactly like this. There is a
broad improvement in US market averages.

This chart above is for the long-term oscillator for the pivotal US Banking
Index that already turned up a week ago, as shown by the green arrow. It would
be very difficult for US stock market averages to decline if US financial stocks
are in a new uptrend.

In summary, these oscillators show how oversold various assets have been.
Asset prices usually start to rise again after the oscillator has bottomed at the fully
oversold level and turned up. I have found that this often happens when just when
the worst-case scenario has been factored into current prices. I have also found
these oscillators to be more accurate than any other indicators I have found.

The reversal in the very long-term oscillator for the US$ Index is an important
indication that investors are once again becoming comfortable with risk. The
oscillators for the US$ Index and the Volatility Index suggest that this has been a
very serious selloff even though the S&P 500 only dropped 20%. The shares of
many technology and innovative companies have been slaughtered since February
2021. Therefore, this bear market, together with two years of high volatility could
usher in a powerful new longer-term uptrend that few are anticipating with all the
pessimism that presently exists. This is what happened in after 1994.

The long-term oscillators for the S&P 500 Index and Russell 2000 indicate
that they could be starting a new uptrend as investors are becoming more
comfortable with risk. Surprising news of better revenues from JP Morgan and
Citigroup early last week continues to bolster the all-powerful financial sector.

The chart below from Investors Intelligence shows that optimism stayed
below the neutral level for a longer time and was lower than any other time since
mid-2018. You can see that optimism has been increasing lately. There are many
indications that this correction could be over as investors become more confident
and willing to assume risk. Even if interest rates rise another 1% or so, the returns
on cash and government bonds are still lower than the rate of inflation.

Corporations are just waiting for signs that this correction is over before massive
share buyback programs kick in again. Pension funds are receiving more and
more cash that they have to invest to provide pensions for workers. I will keep
you informed as the pendulum of confidence swings back and forth.

 

SAR Update

Our team has been much busier lately. Here we are preparing our stretcher on a
wheel to carry an injured hiker down the trail to an ambulance on a recent
weekend. Her injuries were not serious. It is however reminder that rocks and logs
can be very slippery around rivers and waterfalls! Have a good weekend my
friend!