For the past few weeks, I've been closely monitoring sentiment.
Sentiment indicators measure what investors think about the markets. This class of indicators includes the weekly survey conducted by the American Association of Individual Investors (AAII).
I've noted several times recently that this survey dates back to 1987. For an average week, 38% of investors are bullish, 30% are bearish and 32% are neutral. I believe it's important to consider those long-term averages when looking at the current readings.
Last week, just 28.6% were bullish, almost 40% were bearish and 32% were neutral.
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Currently, the number of bulls remains unusually low. More than 70% of investors are bearish or neutral.
This is important because the stock market moved higher last week, and investors suffer from FOMO.
Fear Of Missing Out, or FOMO, is formally defined as "a pervasive apprehension that others might be having rewarding experiences from which one is absent."
Less formally, FOMO is the fear of regretting a decision. FOMO completely explains the cryptocurrency mania that developed in 2017.
Two years ago, few investors understood what bitcoin was. Yet, they were buying because they feared that bitcoin would create great wealth and they would have missed out on the next big thing.
That wasn't the first time FOMO led to a market rally. Internet stocks in the late 1990s also moved up because investors were worried about missing out on gains. In fact, FOMO explains every bubble since tulipomania gripped Holland in late 1637.
Right now, FOMO could be setting up a tradable stock market rally. (There's one easy way you could trade it, brought to you by my colleague Jim Fink. For details go here.)
A "Dangerous" (But Profitable) Market Rally
It's important to acknowledge that the fundamentals don't support a rally. Neither does the economic data. But none of that matters when investors have billions of dollars in cash and a desire to buy.
In hindsight, it's obvious that a market unhinged from fundamentals is a dangerous market. That was true of bitcoin, internet stocks during the bubble, and tulips in 17th century Holland.
That means this could be a dangerous stock market. Fundamentals do not support gains.
Standard & Poor's analysts expect earnings per share (EPS) of the companies in the S&P 500 to increase 6.8% this year compared to 2018. For 2020, EPS is expected to increase by 12%. Those are aggressive – and optimistic – estimates given almost all economists agree economic growth is slowing.
Rather than lowering the estimates, I will assume S&P is correct and EPS for the companies in the S&P 500 will be $181.42 next year. EPS for the index is weighted just like the price index is weighted. If the price-to-earnings (P/E) ratio is 17 at the end of next year, the S&P 500 would be at about 3,084. With an average P/E ratio, the index would gain about 3.6% in the next 15 months, based on fundamentals.
But the index isn't going to be priced based on fundamentals in the next year. Fear will drive the stock market over the next year.
For now, the fear of missing out on gains will be the dominant fear, in my opinion. If the economic news worsens, fear of recession will become dominant, and that could lead to a bear market. Prices driven by fear tend to move far away from fair value.
This is the kind of market where momentum indicators tend to be useful. The chart of the SPDR S&P 500 ETF (NUSE: SPY) below shows that my Income Trader Volatility (ITV) indicator is bullish.
Action To Take
To trade this market, I will be following sentiment and momentum indicators because they tend to work well in emotional markets. Eventually, fundamentals will matter. But that won't be the case until the end of the bear market, which is most likely a year or more away. For now, momentum is up, and that means prices are more likely to move up than down.
Aside from my own indicators, I'll also be watching what my colleague Jim Fink is doing.
Jim has fine-tuned a proprietary but very simple investing technique that generates steady income. It makes money for his followers, no matter what’s happening in Washington or in the markets. Jim’s returns are so reliable, they look just like a paycheck. With his system, you can collect regular deposits of $2,950 or more, every Thursday.
We explain exactly how Jim’s moneymaking technique works, and what you need to do to earn your first “paycheck” using it. Click here for all the details.