6 STATS FROM THE PAST 6 YEARS THAT CREATE CRYSTAL CLARITY
This article also published on Forbes
"What is obvious is obviously wrong" is one of my favorite market mantras. Just like any market mantra, it is subject to the conditions of the market at the time. There is no rule in the markets that hasn't at some point or another been broken for profit. What you consider to be absolute sin in trading or investing is another mans livelihood. And what you consider to be the system or method of thinking that bought you the house with a white picket fence is what has another man residing in his van down by the river.
At any given moment, there are groups of traders who are scratching their heads, punching their computer monitors or vomiting on their desk because what they thought was a golden ticket turns out to be anything but. The markets, at some point or another, makes a mockery of every participants genius regardless of background, religion, color or creed.
I bring this up because of an internal conflict that I faced as an investor during the past week. I have numerous points of data that are pointing to the fact that nearly everybody is as bearish as can be on the US markets due to continued gridlock in Washington. At the core of my soul as a speculator lies a belief that the market hates being predictable and despises participants who feel that they can profit from predictable situations.
At the same time, I have been through my fair share of governmental conflict over the past 17 years trading and have seen countless examples of these conflicts rendering traditional indicators used to pick turning points in markets useless. I personally know of many professionals in the markets that were blown out of the water by the statistical outlier that the second half of 2008 became. Traditional indicators, mantras and even the most sophisticated quantitative studies fail miserably during such events.
My analytical mind is telling me that pessimism is at an extreme according to various indicators that I track and the markets are very oversold, again according to various indicators that I track. My experienced mind is telling me that we may be entering a point over the next few weeks where the market will hurt those traders or investors who rely on such studies. It may be a moment in time where what is obvious is obviously right.
Given the steel cage match ongoing between my analytical mind and experienced mind I decided to look at some simple indicators of investor sentiment. I paired the investor sentiment numbers with a couple of standard overbought/oversold indicators to see what has happened when the markets have begun selling off when pessimism was high and the condition became oversold so quickly.
I don't want to bore you with the details of the parameters I used or what indicators I used. The results were anything but boring, however. Quite telling, in fact:
Over the past 6 years:
- 9 is the number of times we have experienced such pessimism paired with heavily oversold readings as we are experiencing now
- 6 is the number of times the markets (S&P 500) were higher one month later
- 6 is the number of times the markets (S&P 500) were higher three months later
- 1.36% was the average the S&P 500 was higher one month later
- 2.32% was the average the S&P 500 was higher three months later
- 14 is the number of months since we have last seen this level of pessimism paired with such oversold conditions
The most interesting aspect of this study into the results of excessive pessimism meeting oversold markets is that the last 4 times we have experienced such a dynamic the markets have declined by double digit percentage within the 3 month period each and every time. This is followed, in most cases, by a snap move right back up following a short period of downside volatility.
This study validates what my experienced mind has been whispering to me this entire week. My analytical mind will have to take a back seat to the experienced mind for the time being.
In the meantime, you may want to relinquish your mental choke hold on conviction in technical and sentiment based indicators. We could be facing a period where the markets will punish those who put their faith in such devices.
