The Swinging Pendulum Of Market Sentiment

The movement in market sentiment is similar to that of a pendulum that swings back and forth. Market participants swing from greed at one extreme to fear at the other. The stronger the pendulum swings in one direction, the stronger it tends to swing in the other. This Summer and Fall the pendulum swung deep into fear territory, which is why it was able to swing back so hard since then.

It was an easy decision for me to get long into the extreme fear in the Fall (less easy to actually suffer through it) as I was pretty certain the pendulum would eventually swing back. However, now that we are back in greed territory it is a much tougher decision to gauge how far in we will swing.

Many of the indicators I follow are in territory that have previously led to corrections, even in the context of bull markets. The caveat is that last year these indicators did not work very well as the market stayed in a state of euphoria from late December until the March correction. All these gains were eventually erased in March but it was painful to be on the wrong side of the move until then, as I can attest to.

We are faced with market conditions that have most of the time led to fleeting gains at best. However, as last year demonstrated these conditions can last awhile. Making the decision more difficult is the fact that valuations are a lot better this year as earnings have risen but the market is in the same place. Given all these cross currents my decision to hedge and move to a modest net long stance seems appropriate.

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