There are a lot of scared investors out there right now. After what seemed like five years of stocks doing nothing but rising, investors are worried after the latest drop.
Last week I spoke at the World Money Show in Orlando. After my presentation, I had lively conversations with many of the attendees. And let me tell you, some of them were plain freaking out.
At that point, the market was down a little more than 4% from its all-time high.
Let me repeat that just so you can appreciate how silly it sounds. Investors were freaking out after the market dropped 4% from its all-time high.
That doesn’t mean the market can’t drop further, or even become a real correction. I can’t tell you definitively that it will or won’t. I decided against the premium package for my crystal ball so I only get information on specific stocks, not the broad market.
But let’s take a look at a few factors that suggest that we likely have not entered the next bear market.
The initial drop was too big. Bear markets typically don’t begin with big scary drops like the ones we’ve had the past month. As of the close on Monday, since hitting a high on January 15, the S&P 500 dropped about 5.25%. Such a hasty move is more correlated with bull markets than bear markets. Down days in bull markets tend to be more violent than in bear markets. Usually, a bear market will just grind you down, not scare the pants off you.
Where’s the euphoria? I’d be more worried if the investors I spoke with last week all told me they were using the sell-off to back up the truck on speculative stocks. Bull markets end when investors are euphoric, not when they’re scared.
Above is a well-known chart of investor sentiment and how it relates to the market. Before the sell-off, I’d have argued that we were somewhere around excitement. After five strong years, investors were finally starting to wake up and put some of that cash that’s been sitting on the sidelines since 2008 to work.
I’ve seen nothing to suggest we’ve hit the euphoria stage.
One could certainly argue there is anxiety, but without having hit euphoria, I don’t see a bear market setting in.
Additionally, according to the American Association of Individual Investors Sentiment Survey, only 32% of respondents are bullish. Another 33% are bearish. In this week’s survey, the bullish number dropped six percentage points, while bears jumped nine points. Bulls are now seven points below the historical average and bears are two points above their average.
That’s useful information for those who like to go against the crowd. But the survey is especially helpful when either side gets to extremes. Exceptionally bearish sentiment is almost always seen at bottoms – whether we’re talking bear market bottoms or just a mild decline. Bullish sentiment often peaks at market tops.
So while we’re not at extremes yet, sentiment has moved into the bearish camp.
There’s no technical confirmation. Although the market has been ugly the past few weeks and some stocks have suffered technical damage, a quick look at a long-term chart of the S&P 500 shows that the uptrend going back to 2011 is still intact.
There’s a saying that a trend in motion tends to stay in motion. In other words, a trend usually stays a trend until it doesn’t. And as of right now that trend is in motion.
The S&P 500 has come back to the trend line, which is a good place to buy if the index remains in an uptrend. If it doesn’t we’ll know pretty quickly as a dip below 1,700 would signify a break in the trend line. A new low below 1,650 would be concerning.
While the market downturn may be scary, I’m not seeing anything to suggest that a new bear market is upon us. I suspect this will turn out to be a good opportunity to load up on some quality stocks that you’ve had your eye on for a while but didn’t want to buy after a straight run up.
So if you are freaking out, the evidence above will calm your jangled nerves like a belt of whiskey.
View original at: Investment U
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