Strong November Rally is Stretched and Suggests Some Caution
Last week we discussed the extreme bullish readings in the AAII Sentiment survey. Statistically, the difference between the bulls and the bears was at the 95% confidence interval. Historically, this marks an extreme condition and on average, the probability of return over the next year tends to be well below average while the odds of a more than 10% correction increase significantly. The theory here is that with most investors saying they are bullish, they are likely already in the market and there is not much cash left to buy. If far more investors are bearish, they are likely in cash and have lots of buying power.
This week we are looking at mean (trend) deviation. The markets tend to trend away from their average price for so long and by so much before they revert to the mean or slow the trend. There are many factors that make up our new Berman’s Call Probable Return on Investment Indicator (PRO-II: Call it Pro Eyes). Each week for the rest of the year we will look at another factor and the indicator will be formally launched and published in early 2021 on the BermansCall.com blog. The origin of the indicator stems from my CMT thesis paper that I wrote 25 years ago. It was initially written to track the bond market and I’ve modified it for equity markets. It’s a combination of fundamental and technical indicators that provides a probability score for the market rallying or declining. Many may remember earlier in my career I was the fixed-income strategist for CIBC World (Capital) Markets when I first started as a guest on Market Call over 20 years ago.
We have been following the CNN Fear and Greed Indicator for many years and it has done a very good job telling us when we should be cautious or aggressive on markets. I like to call it a a buy low sell high indicator rather than fear and greed. I think we need to minimize the emotional influence on investment decisions and fear and greed are the epitome of emotions. Last week the CNN Indicator entered the extreme greed range at 91/100. The CNN gauge is very good, but it lacks a few elements that our indicator includes and it provides some differences in technical indicators too.
In terms of trend following and when it hits an extreme, CNN looks at the difference between the price of the S&P 500 and the 125-day average (approximately 6 months of trading days). I like the 200-day average for the simple fact that there are so many eyeballs on it and I’ve observed over the years it tends to act and a meaningful pivot point for many investors. Our chart today shows the indicator value over the past few years that included the highs and lows in 2018 through today.
The statistics around the trend deviation element of the indicator are interesting. Like the CNN indicator that uses 125 days, a reading over 90% since 1928, suggests that in the next 200-days, the probability of a 10% correction is significantly higher than when the market has not deviated so much from the 200-day trend.
Don’t miss the final Berman’s Call virtual roadshow on Thursday Dec 3 at 7pm ET where we will be showing more of the elements in our new PRO-II (pronounce Pro Eyes) Indicator. If you missed one, you can see all of the replays here. Sign up for the series by clicking here. The series will run every Thursday at 7pm ET through December 3. There will be lots of opportunity to ask questions of markets and your favourite ETFs and stocks.
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