DrKW Fear & Greed Index

On balance in life I am an optimist. Lots of bad things do  happen both to and around us, and we all die.  But as Maya Angelou, the poet, said, "I am convinced that the negative has power, and if you allow it to perch in your house, in your mind, in your life, it can take you over." I think she meant this on  several very important levels.

In daily and intermediate term life, including investing, I'm an optimist, most of the time. Given over 200 years of rising prices of investment vehicles in the US, the last 100 years of which are very well documented indeed, it is well  to have a bullish bias  for the longer term.  For some quite substantial meat to put onto these philosophical bones, see  "Triumph of the Optimists: 101 Years of Global Investment Returns" by Dimson, Marsh, and Staunton, Princeton University Press, 2002.

Given my preference, beliefs,  or bias, I generally do not pay much attention to those whom we might consider to be "perma-bears" on economies and markets. They will be right on occasion, as even the old broken clock tells time exactly, twice each day. My opinion  is that John Mauldin falls into that group, given his mentoring by Gary North and his close friendship with Bill Bonner, both great marketers of gloom and doom.

Nevertheless, Mauldin's gloom and doom sound brilliant to me when I am in one of my "could go down" periods of analysis. In Mauldin's latest free weekly letter http://www.frontlinethoughts.com/printarticle.asp?id=mwo021006 he presents a fascinating  sentiment indicator from James Montier of Dresdner Kleinwort Wasserstein.

Mauldin quotes from Montier: ""It is really a measure of relative risk adjusted momentum between global equities and bonds. When the risk adjusted performance of equities is high relative to the risk adjusted performance of bonds, then investors start to forget about the concept of risk altogether; they become totally focused on return. Irrational exuberance reigns (shown as a reading of above 1 in the chart below)."

"In contrast, when bonds have performed well in risk adjusted terms relative to equities, investors tend to forget that things will generally get better at some point, so this creates the 'end of the world is nigh' kind of feeling (a reading of -2 in the chart below). Effectively, the measure captures the tendency towards extrapolation of the recent past/current situation into the indefinite future. Thus it serves as a contrary indicator."

Given Montier's interpretation of his own indicator there were some questionable top calls (>+1) on his chart from 1984-2006, all of which you can see yourself below. However if  one draws a line at +2 (as I have done on his chart) there have  been only three tops calls (and a famous near miss) since 1984: 1987, 1996, and now in 2006, with the very near miss in 2000. If you weren't investing in 1996 you may wonder about that one. But after an amazing year of marching up all through 1995, early 1996 was wildly bullish. Even with the pretty severe correction that year, Greenspan was moved to make his "irrational exuberance"  comment late in 1996.

My point is that Montier's indicator has good "genes" and a great performance history at tops. The >+2 cutoff is signalling a reversal to bonds from stocks. Personally I am not a fan of bonds due to where we are in the long term Kondratieff Wave cycle of inflation and interest rates. With short term rates as high or higher than 30 year bond rates, anything farther out than tomorrow in a money market fund seems very risky to capital.  But I am not a bond trader, and perhaps that's what bond lows are like. I"ll need to see some bond low confirmation to get long in  bonds, although my own work on  gold and commodities generally suggests a decent pause in the commodity bull market. In the Long Wave cycle, bonds and commodities will trade in opposite trends, but pauses and corrections occur in all trends, so a bond rally isn't at all impossible.

The other side of the momentum indicator is the irrational exuberance for stocks which I have been seeing and showing you  for a while in several different ways. My own fairly conventional market-based sentiment indicators have gone wild and topped in late December and again in January. Chairman MaoXian's media-based sentiment indicator reached an extreme point,  not seen since 2000, in the last days of December. Loekke's cycle work, which I see as a sentiment measure, Terry Laundry's T's, and other cycle studies are pointing to the same outcome.

Two of the prior sell signals for stocks on Montier's indicator (by my >+2 interpretation) were HUGELY rewarding, but 1996 was not. Nor  do I know his model or parameters. So  I would say that Montier's is predicting a stock correction but not necessarily a huge one .