Irrational Exuberance

Our esteemed and beloved past FED chair, Alan Greenspan, coined the term Irrational Exuberance describing investor’s excessive enthusiasm towards (at the time dot com) stocks, his way of hinting the markets were overvalued. Knowing the markets are driven by investor emotion, not fundamentals we know over or undervalued markets can stay that way for really long periods of time. Eventually when those emotions are driven from investors (or supply/demand dries up) the markets revert.

As such, investor sentiment is a valuable tool to watch.  It’s not the end all be all, rather another tool in the toolbox.  Since there is no perfect way to measure sentiment it’s easy to get wrong signals. This is another reason to reinforce the fact no indicator works all the time except. The only thing that is ALWAYS right is price and why we use indicators as confirmation tools (of price) only.. I have found that in general and with all sentiment gauges, extreme reading are really the only readings that can matter. With that in mind I wanted to show a couple of current sentiment gauges I follow and their current readings. The first is CNNMoney’s fear and greed index. Here is last Thursday’s index reading on the close

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To put this into context, here are the readings over the past 3 years.

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The fact we are at the highest level in the past 3 years should be concerning as stocks are extremely overextended short term. 

A second sentiment gauge which is the University of Michigan’s consumer sentiment index. Dana Lyons at the Lyon’s Scare combines the sentiment index readings alongside the SP500 index. As you can see this helps put into context the value of extreme readings and their relationship to stock prices. I have included this chart below.  The SP500 price is in the top pane while UofM sentiment index is at the bottom.

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 No matter where I look, and however I attempt to rationalize current prices the fact is we are massively overbought and extended. In normal markets and depending upon your investing time frame, these conditions are typically times to lighten up and wait for a pullback to re-enter. Otherwise, the probabilities are you would likely be subjecting yourself to increased risk.  But so far this market has been anything but normal. With seasonality at our back and the fact there are still enough bears that have yet to drink the kook-aid, it looks as if  this market has room to move higher. That is only after we have had a chance to unwind the short term excessive irrational exuberance,