A few years ago, I was invited to play a round of golf at The Country Club in Brookline, the site of this year's Ryder Cup. I was standing in the rough on the 18th hole when I looked to my freckle-faced caddy for some club advice. "Gee, Mister," he mumbled nervously, "I think it's somewhere between a 7 and an 8." To calm the lad, I responded, "Don't worry son, I'm an investment professional. Give me a 4 iron." As the ball bounced off the clubhouse terrace, I reveled in my first, and last, walk up the 18th fairway.
In case you have a life and missed the Ryder Cup this past weekend, had it not been for a "Just-In Time" Leonard putt (my apologies to Red Smith) that was longer than
lifeline, the American squad would have been humiliated on its home turf. I don't want to rain on anybody's plus-fours parade, but conventional wisdom had it that this thing was over for the Europeans before the first foie gras was consumed in the hospitality tents on Thursday morning. How could the professional consensus have been so wrong?
must have had a good chuckle up in heaven.
Bernard Baruch? If you've never heard of him, I recommend a trip to the local library. You can't really consider yourself a serious student of investing unless you've read about this fellow. In addition to being a man of some historical importance, he was, for my money, the greatest investment mind of the 20th century. His basic tenet was that conventional wisdom, or consensus, is inevitably wrong. Sure, in the short term, you can run with the pack and make a few bucks, but to amass some serious green, you have to swim against the tide.
I'm a big fan of following consensus indicators to get a sense of what the masses are thinking and doing. When the pendulum swings too far in either direction, it may behoove you tactically to heed Baruch's advice and "buy your straw hats in the winter."
The VIX index is a somewhat complicated measure of expected volatility derived from option pricing. With all due respect to my quantitative brethren, I refer to it as the fear index. Basically, the greater the level of fear in the marketplace, the more investors are willing to pay for insurance via the options market. Conversely, when everybody's just downright giddy, who needs a safeguard?
Increasing fear means an increasing VIX and declining fear translates into a declining VIX. From a contrarian standpoint then, when investors are scared and the VIX is high, it's time to buy. When that dreaded "new paradigm" stuff gets trotted out in the popular press and the VIX is low, it's time for some cash under the mattress.
For most of this year, the VIX has been in the low 20s and it's ranged generally from 18 to 30. Can you guess when it was at its low? Here's a hint: The
was 1418, its mid-July high-water mark for the year so far. Last fall, when the world was ending, the VIX was in the 40s -- nosebleed territory for this indicator. Right now, we're in the high-20s, which is mildly bullish from a contrarian's perspective, but not convincingly so.
Investor sentiment is one of my favorites. Investors intelligence (an oxymoron?), available in
, does a survey of bulls, bears and those who are bullish in the longer term but expecting a near term correction (I call them chicken bulls). If you add up the percentage of bulls and chicken bulls, you get a sense of what people think of the market. This measure has contrarian appeal since it's safe to assume bulls and chicken bulls are close to fully invested, with little cash in the till. If everybody's invested and something unexpectedly bad happens, everyone sells at the same time. If there are more bears than bulls and chicken bulls -- meaning investors have lots of cash since they don't like the market -- the opposite takes place: Some piece of unexpectedly good news sends them diving in en masse with their cash, forcing the market higher.
What was the percentage of bulls and chicken bulls at the market highs this year? It was 73% -- 55% bulls and 18% chicken bulls. Two months later, the S&P was down 142 points and the
was 710 points lower. As of this writing, bulls and chicken bulls are at 70% (43% bulls, 27% chicken bulls). If I were forced to take a side, I would say this is mildly bullish in the short term, but, as is the case with the VIX, the argument is not convincing.
Yes, Virginia, even the oft-under-appreciated bond market (my home) has its share of sentiment indicators. Two of those are market vane (
) and the trader's commitment or hedgers/speculators report.
This is the bond-market equivalent of the investors intelligence (man, I just hate saying it) report. It measures the percentage of investors bullish on interest rates (lower rates mean higher bond prices is, I think, the way it works).
Over the past year, the market vane indicator has ranged from close to 90% bullish down to 20% bullish. True to form, bond investors were most fervently convinced that yields were heading lower when the long bond yield was 4.69% last fall. When were they least bullish and most convinced rates were only headed higher? That was at 6.20%. What's most interesting is that the historical lows for bullishness have occurred quite recently, with a scant 23% of bond investors currently bullish.
The traders commitment report is a little arcane, I'll admit. Though at first blush, this one is pretty complicated, it's the message not the calculation that's important. This indicator measures activity in the futures market and tries to determine who is trading futures for legitimate, risk reducing hedging purposes (hedgers) and who's rolling the dice in dreams of early retirement (speculators).
The report further divides hedgers and speculators into bulls, or those expecting lower rates (long futures), and bears, or those anticipating higher rates (short futures). It's the speculators to focus on, since the only thing funnier than a speculator is a speculator on the wrong side of the market. When a preponderance of speculators is either bullish (long) or bearish (short), it means that if the market moves away from them, they have to cover their bets in a hurry or risk being at the listening end of a Jack-in-the-Box drive-through microphone. Currently, there are more than twice as many dollars bearish as bullish. If stocks falter, the economy slows or inflation doesn't materialize, rates could be headed much lower than most people think.
Though many sentiment indicators have contrarian intellectual appeal, they should be viewed as tactical -- as opposed to strategic -- opportunities. To insure long-term wealth creation, you should develop a strategic view of the future and invest accordingly. Strategic asset allocations should reduce the anxiety of day-to-day noise: I personally don't spend much time analyzing how Chairman
parts his hair. Tactically, though, you can make a few bucks on the other side of excessive market sentiment, and it sure is fun to watch the cigar-smoking, cell-phone-using pros be wrong.
Jim Sweeney is the head of fixed income investments at Aeltus Investment Management in Hartford, Conn. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. Aeltus manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. While Sweeney cannot provide investment advice or recommendations, he invites you to comment on his column by writing his colleague Jim Griffin at