Pessimism is in full swing this August. The doom and gloomers are telling stories about global slowdowns, Chinese currency wars, an over-supply of commodities and political uncertainties. The future, according to them, looks certainly dim. And yet for another group of investors (a less-vocal minority), the bright sparks of opportunity are lining up. Remember that even when markets decline, there’s a buyer for every seller. So what do these buyers potentially see that the sellers don’t?
First, we might look at volatility, and how much to expect in the near future. The “VIX” measures expected volatility over the next one month. Its cousin, called “VXV”, measures expected volatility over the next three months. By comparing the one-month to the three-month expectations, we can figure out if volatility should be short lived, or persist. On the chart below I’ve circled all the instances over the past two years when volatility, based on this comparison, was expected to be short-lived. The nice thing about these spikes is they coincide with attractive entry points in the stock market. Of course we don’t yet know how this current spike will be resolved, but if it’s anything like the others, we have a good chance at higher prices.
Next, we can look at the “put/call ratio”. The put/call ratio measures how many traders are buying “crash insurance”. Ironically, history tends to show that by the time traders buy lots of crash insurance, the pessimists have already gotten ahead of themselves. In the chart below I’ve circled in green what that looks like. You can see that every spike of the put/call ratio for the last four years has resulted in a higher stock market. Again, we don’t have any guarantees how it will play out this time, but the probability looks favourable.
Another item buyers might be looking at is the old “cash on the sidelines” argument. The chart below shows that investors of all types have been selling and moving into cash en-masse. According to the chart, the current level of cash inflows has coincided with attractive entry points in the stock market’s recent history.
Finally, there are research groups that pay close attention to the feelings of advisors and investors. These groups track self-reported surveys to gauge investor sentiment. In the chart below, we see that over the last four years, elevated pessimism tends to mark low points in the stock market.
Of course we don’t know exactly what all the buyers are thinking, so trying to time the market is a tough business, and not recommended. But applying some simple rules to the market can be helpful in determining the big picture. As long term investors, we’re afforded the luxury of not having to be perfect in every buy and sell. The advantages of this long term thinking, along with discipline and a rules-based approach, help us get the easy stuff approximately right.
Beyond our actions and professional capabilities, it’s our outlook that determines success the most. The future belongs to optimists. Always has, and always will.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.