Obiter Dicta: On Sentiment

My last post provided a fairly light hearted introduction on informal measures of market sentiment, but during these uncertain times I tend to reflect upon the copious amounts of reading I have done on sentiment to try and get an understanding of where we are in the current climate.

Two books that I have recently finished, Mark's The Most Important Thing Illuminated and Neill's The Art of Contrary Thinking highlighted that market sentiment often swings in a pendulum like motion between extreme fear and extreme greed. One way for an investor to make significant gains is to recognise where we are in the market thereby exploiting opportunities as they arise. By and large the most gains can be made when you can keep a cool head and calmly make purchases when the majority of the population are panic selling and selling (or at least reducing purchases) when prices start to overheat. As such, I have spent a considerable amount of time pondering sentiment and relevant indicators and have made the following observations of different gauges.

Quantitative Indicators 

Stock Market Price

It would be hard to argue that there is a stronger indicator of market sentiment than the market pricing itself. In stating the obvious, the current price of a stock clearly represents what the market considers to be fair value as at that one point in time. The PE ratio gives a ratio of earnings per share to each share price which in turn provides rough guidance on whether a share is over or under valued. A further step would be to consider the Forward PE ratio to gauge the expected growth and earnings. The higher the Forward PE ratio the higher the predicted growth of the stock which gives a crude starting point for the market's disposition.

Relative Strength Index

The RSI is a momentum indicator that provides a measurement on whether stocks are currently overbought or oversold. The calculation for RSI is fairly complex:

N is often taken to be 14.

The result is a number between 0 and 100 whereby 50 indicates that stocks are neither oversold or overbought, a number closer to 100 indicates it is overbought and a number closer to 0 signals under bought. A range between 30 and 70 is considered fairly normal.

Using the current example of what has just happened locally, you can see that the market crash at the end of February corresponded to a sharp decline in RSI correlating with in a massive oversell of equities in March. A savvy investor would then recognise the market panic from these charts (amongst all the other factors) and may draw the conclusion that it would be a good time to make some purchases of some good quality value equities for a good price.

Bond Yield Curve

The Bond Yield Curve has recently been cited often as an indicator of impending recession, however there is far more information to be gleaned from it than just the one omen of impending doom. Going back to basics, a bond's yield tells you what the annualised return is from purchase to maturity. As is with the laws of uncertainty, it is riskier to purchase a bond for a longer duration than a shorter one (because you can never really know for certain what will happen in the longer term future) and accordingly in normal situations long term bonds will tend to attract a higher yield than short term.

For reference, our current bond yields in Australia are as follows:

Our current yield curve looks like this:


Different orientations of the curve give different hints to what can be expected in the future.

Normal Curve - has a lower short term yield with a mild increase to mid term and long term. This indicates a normal level of confidence about the future.

Steep Curve - has a lower short term yield with a much greater mid and again much greater long term yield. It is a very bullish signal and has historically correlated with rallies in the stockmarket.

Flat Curve - indicates a lack of investor confidence in the future and is a moderately bearish indicator, although not as bearish as the inverted curve.

Inverted Curve - occurs when short term bonds produce a higher yield than long term bonds. This demonstrates that investors are expecting a drop in yields over the long term as well as a high risk in the short term. This is a very bearish indicator and is often portrayed by the media as a sign that a recession is imminent, whether or not that is true is another matter for a separate debate.

Qualitative Indicators

Pendulum of Hysteria and Euphoria - Changing times?

Moving away from the highly technical quantitative indicators, I find that having an understanding of investor mood through qualitative signs is also important in pinpointing where we currently are on the pendulum swinging between hysteria and euphoria.

There are a number of sources that I have referred to, each with their own limitations. The news is an obvious starting point but the media always sells more by playing up the fear factor, so this often ought to be taken with (at least) a grain of salt. Friendly conversation with friends and coworkers can also provide insight into what your peers are thinking, but of course you are narrowing down your sources to your acquaintances which may only represent a small segment of broader society.

A resource that I have found somewhat insightful over the years is Reddit, specifically the subs investing, fiaustralia, ausfinance and wallstreetbets. Although you are also limited to a demographic of people who are clearly computer savvy enough to post and engage with the online community, it provides a less biased account of reality.

A snapshot of some posts on Ausfinance today results in the following:

For those who are reading this post after the fact (which will probably be most of you), the ASX dropped 36% from a peak of 7162 on 20 Feb 2020 to a recent trough of 4546 on 23rd of Mar 2020 and has since rebounded quite violently 13% to 5181 today 31st Mar 2020. Since the initial panic that was caused by the crash which lead to a considerable amount of selling off (see RSI) there have been a notable amount of investors who have joined the bear gang and attempted to recoup losses by way of buying inverse indices such as BBUS and BBOZ or for the more sophisticated traders buying put options. This had been going on for a couple of weeks now and resulted in a number of oversimplified principles  such as "buy puts = free money" "all in BBUS". The mood on the relevant boards quickly changed from despair to euphoria when the masses of retail investors learned that they could grow their wealth at an accelerated rate by using these highly risky, leveraged products.

As mentioned above, we have since experienced a considerable uptick in the last week and the posts in the screenshot provide a good indicator of how the typical retail investor is reacting to this market movement. From hope of a bearish future with the prospect of incoming defaults and further falls anticipated in equities to the user who invested his whole life savings into BBUS and BBOZ it is clear that they are all anticipating further falls in the market. Whether or not we have reached the extreme end of the pendulum is anyone's guess but these posts seem to indicate that even if we haven't, we ought to be fairly close.

Another interesting note on the matter though, traditionally retail investors were not sophisticated enough to buy inverse indices or puts as these products have only been made available to the masses relatively recently. I would suggest that with these products being made available, an adjustment to our pendulum ought to be made to reflect this, since once the market has clearly taken on a downward trend, euphoria can be found in retail investors who have bought inverse indices or puts where traditionally there would only be hysteria. It would seem that now hysteria only really arises when the market turns and those who missed the signals are caught like a deer in the headlights.

Keynesian Beauty Contest

One final qualitative measure that I will touch upon today is the Keynesian Beauty Contest. For those who are unaware, rather than the traditional beauty contest where participants are asked to choose who they consider to be the most beautiful, they are asked to choose who they think will be voted most beautiful, i.e. crowd consensus. In other words, it constitutes a game of sentiment whereby the winner is the person who can guess better than the crowd as to how the crowd will behave.

In applying this back to our current situation with Covid and the lockdown that I find myself in, we have seen not infrequent headlines whereby the crowd has bought into the hype that the shutdown that we face will be ongoing for months on end, tens of millions of people around the world will die from this virus and the markets will never recover ever again. The most important question though is that although this is what the crowd believes will happen, is this likely to be a realistic outcome given our fundamental understanding of human nature? I would argue that it is not.

In closing, I would like to round off this post with some words from, Warren Buffett, “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”.

by 小福

Random Musings: Hot Waitresses, Mens' Underwear and Lipstick

Since my last post just under two weeks ago, Australia has plunged into the second stage of a lock down, my work has finally handed down a work from home directive and I haven't left the house in four whole days. Whilst I have been home bound, it has given me ample opportunity to further my studies and readings on finance and the broader economy whilst this volatile situation unfolds.

One of the things that appeared as a recurring theme across books that I had read was sentiment. Essentially that it is important to have a firm understanding and ability to grasp what the market sentiment was so that we could comprehend where we currently are on the fear-greed pendulum. Among all all my technical technical readings I came across three informal measures of sentiment which I came across on Investopedia. All three are quite interesting albeit crude measures. Having taken a look back at my last several posts which have been quite sombre, I thought it would be apt to share these with you to lighten the mood a bit.

Hot Waitresses

So the idea with this measure is that next time you have a meal out, you take a look at your waitress to see if they are relatively good looking or not, because according to the index, the higher the number of good looking waitresses there are, the weaker the state of the economy. The idea behind this is that during times of plenty, attractive people will be able to find and abundance of employment in other jobs. As these jobs become less available during times of crisis, by the laws of supply and demand, they will find themselves in hospitality jobs like waitressing (or waitering).

Mens' Underwear

Prior to Alan Greenspan's research in the 1970s, mens' underewear was largely viewed as a necessity rather than a luxury, which would mean that sales would largely be static despite a change in the economic climate. However what the research in fact proved was that during times of economic decline, men tended to wear their underwear until it was threadbare rather than get new ones, an interesting contrast to womens' underwear purchase habits. Complimentary to this study, similar results were shown for things like clothing alterations and haircuts. Having said that, I am only privy to the condition of two mens' underwear, being my father and my ボーイフレンド. If you looked at their underwear as a basis to assess the economic climate we are in, you would think we are in a perpetual never ending depression, so my personal anecdotes seem to refute this research.

Lipstick

Our last informal indicator is lipstick. So rather than having an abundance of fresh crisp new underwear when the economy is booming, women tend to indulge in other luxuries such as designer handbags or outfits. The idea is that when the economy is faltering, women still want to indulge themselves and instead purchase smaller luxury goods as a sign of comfort such as lipstick, which would mean that the higher the lipstick purchases, the worse the economy. Again, if I applied this indicator to my own purchases of lipstick, you would think we never got out of the depression. Either way, it is an interesting way to consider indicators of market sentiment.

By 小福

Trials and Tribulations: Three weeks and 30%

Tuesday 17 March 2020. As I write this, it has been approximately three weeks since the market started to drop and since then my portfolio which is largely index based, has dropped roughly 30%(T＿T). Yesterday marked the biggest fall in ASX history at 9.7% and overnight the SP500 lost 12%. Trading halts and massive swings used to be rarities and are now commonplace. The volatility index has risen to 80 and panic has thoroughly set in amongst the broader population∑(￣□￣;). Self doubt has started to creep in on me but my resolve still holds firm. I decided on this course of action four months ago and I intend to see it through to the end._(:3」∠ )_

Indubitably mass hysteria has set in to the general populace, far beyond the financial markets. It is one thing to hear about panic buying of essential goods on the news and another to witness the apocalyptic sight of empty shelves in the supermarket first hand(。•ˇˍˇ•。). Thankfully my household has a heathy reserve of basic necessities. My workplace has not given a directive to work from home or self-isolate, but our organisation appears to be the last stand in a derelict skyscraper. Most of my colleagues are on edge but management refuses to consider the welfare of staff and would rather focus on the bottom line（╯‵□′）╯︵┴─┴.

In the news, I am constantly bombarded with news that large institutional companies like Qantas or UQ are on the verge of going bust as well as predictions of long standing recessions which will take up to ten years to recover from (Deloitte). People whom I respect greatly are predicting a permanent shift in society with far reaching consequences for the long term future and my learnings on holding steadfast to contrarian beliefs are being well and truly tested.( •̥́ ˍ •̀ू )

Only time will tell if I have made the right choice in sticking to my plan, otherwise it will be a very costly mistake indeed.

By 小福

Trials and Tribulations: End of the Bull Run

With my last post and the slowing down of instances of Coronavirus in China, I had thought that maybe my run of bad luck would finally take a turn and I would be able to recoup some of my (not yet crystallized) losses (－_－) zzZ. Unfortunately for me (and the rest of the world), we took a turn for the worse in the last two weeks and the eleven year bull run was finally brought to an end this with the market in free fall across America and Australia ʕ •ᴥ• ʔ.

As I write this, the S&P500 had lost $5.3tn whilst the ASX200 has lost $430bn in the last three weeks and there has been considerable hysteria online and in real life. Everyone regardless of whether or not they bought into the market has a fairly strong opinion on whether or not the virus will cause long lasting economic impacts as well as the associated impacts and flow on effects╮(︶︿︶)╭. 

For the time being, I have learned to stabilise my own emotional responses to the regular losses with a focus on long term gains as I continue to dollar cost average on a regular basis(-_-;)・・・. I thought I had gotten used to drowning out irrelevant opinions as noise, but today I was fairly shaken by the words of my long time mentor Mr L, who I consider to be the most brilliant men I have ever met. Throughout the years, he has given me priceless insights on the machinations of the world, needless to say, I hold him in extremely high regard. As someone who invests heavily in precious metals, Mr L doesn't touch property or stocks, however as I was speaking with him about other matters today, I did mention that I was buying into the dip as the downturn unfolds, to which he very sternly told me that trying to catch a falling knife is a dangerous endeavour ＼(º □ º l|l)/. Frankly, I can discount a large majority of people's opinions and continue my course of action because I consider them to be wrong, but when my most respected mentor also raised these concerns, I definitely faltered in my conviction and spent the whole afternoon pondering my choices. In the end, I've committed myself to going through with this and until I see definitive proof that the strategy doesn't work, I will see it through, but it is definitely taking a lot more determination than I had previously estimated. Hopefully in a few months, this will not matter anymore(×_×)⌒☆.

In the meantime, this is what I think of bears＼＼٩(๑`^´๑)۶／／:

By 小福