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With Emotion Removed, How Healthy is the Market?

Written by: Benjamin Bimson CIMA®, CMT® / CIO, Trek Financial

Sometimes when things are going well, we can be tempted to join the ever-present guessing game of “what will happen next?”

Depending on our personal preference to interpreting events, we can all fall into two categories: “the party is over, or just about to end” category, or the “this time it’s different and things will never be bad again” category. Either way, it’s incredibly difficult to remain fact based when markets have been up so much over the past 12 months. And after coming off the pandemic-induced recession, even attempting to discern our current trajectory is difficult.

On one hand, we have inflation numbers that are above expectations. This can be troublesome for corporate earnings if they continue to remain high. It could also be a signal of massive stimulus and economic reopening finding their footings. On the other hand, positive surprises are still resulting in positive market movements. This is also combined with a healthy market breadth (percentage of stocks that are rising together).

The big question is, with emotion removed, how healthy is the market?

The one part of investing that is very consistent is that investors often become emotional about their investment decisions at some point. Unless you realize how sensitive the “fear index,” (VIX) has been, you would not be able to see how sensitive investors to moves in the market. 

Unfortunately, this measure of sentiment can be a bit troubling to interpret. For example, the current DSI Global Sentiment Composite has an optimistic reading. However, it is not at an extreme. In fact, each of the market pullbacks we have seen during the past month, we also saw sentiment cool down. There can be a temptation to try to outsmart the market and assume that just because this is optimistic, bad things are sure to follow.

The most recent recession has some similarities in the VIX to the 2008 financial crisis. Both recessions approached the VIX mean of 15, which is slower than less severe recessions or bear markets. However, during the COVID induced recession, the VIX has shot up over 30 several times, which historically speaking, is rare. Most bear markets have not developed until we observe a period where we have some VIX stability.

 

Despite the headline risks of inflation, unemployment, politics, and the pandemic, there are not enough conclusive facts to indicate a slowdown in economic improvement. In fact, the percentage of companies who are reporting earnings that exceed expectation is rising – numbers of which haven’t been seen for more than 15 years. If markets continue to respond favorably to earnings beating expectations, and we do not have a new catalyst in the market, we can expect the bull market to continue.

It is a challenge, but if we understand our propensities, we can look at data that allows us to keep the emotion in check. The goal is not to be “right,” but to make money when we can. Data can potentially help us avoid big mistakes, while realizing we can’t avoid all the small ones.


Investment Advisory Services offered through Trek Capital Management LLC., an (SEC) Registered Investment Adviser.

Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed, and past performance is no guarantee of future results. For specific tax advice on any strategy, consult with a qualified tax professional before implementing any strategy discussed herein. Trek FG 21-66

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