The chart above is a good visual reference of our current market state. The top half shows the S&P 500 index’s current distance from the 200-day Simple Moving Average. The bottom chart shows the CBOE Put/Call ratio and its distance from where the market typically ends an intermediate correction. The two graphs move in opposition to each other.
Since my strategy and algorithms are based on mean regression, consider the 200-day line to be the “intermediate” mean. We are a dangerous distance from that line. At a 26% distance, this is more than we have experienced in a long, long time. Mean regression is like a rubber band. Stretched too far, price snaps back with a sting. The sting is proportional to the leverage involved. Suffice it to say, the leverage right now is unprecedented, and the rubber band is due to snap back soon.
Confirming that possibility, the bottom half of the chart is the CBOE Put/Call ratio. The indicator measures the sentiment of retail traders – the crowd that tends to arrive near market peaks. The lower the ratio, the higher the complacency. The ratio has reached the lowest level in my 34-year career. In short, the indicator shows too much bullishness – close to a long-term record.
In other words, excessive optimism is pervasive among retail (not to mention institutional) investors. We only see this near market tops. There is little to no fear in the market, and yet it keeps falling to record lows. As Ben Franklin once said, you want to buy on the canons and sell on the trumpets. The trumpets are blaring – but the question is for how much longer? That is not an easy question to answer.
There are titans in this business. One of those titans, Jeremy Grantham, is In the same league as Warren Buffet or Sir John Templeton. Mr. Grantham is an understated but legendary investor. Born in 1938, he will turn 83 this year. I will be lucky to live that long, much less have his perspective.
Mr. Grantham is a British investor. He is co-founder and chief investment strategist of Grantham, Mayo, & Van Otterloo (GMO), a Boston-based asset management firm. GMO had more than US $64 billion in assets under management as of October 2020. Mr. Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets and is particularly noted for predicting various bubbles. He has been a vocal critic of different governmental responses to the Global Financial Crisis from 2007 to 2010. Mr. Grantham started one of the world’s first index funds in the early 1970s. In 2011 he was included in the 50 Most Influential ranking of Bloomberg Markets magazine.
Every once in a while, I will read something that crystallizes my thinking. There is no point in rewriting or paraphrasing. I could not improve it. Tonight, I would like to share just such an article. “Waiting for the Last Dance,” written by Jeremy Grantham at the end of January. The report is a simple yet powerful presentation of the dilemma before us. Enjoy the read. It is not long.
I will put out the outlook in the morning, as I don’t want to dilute Mr. Grantham’s impact.
A.F. Thornton