2023 continues to surprise. In the closing days of 2022, one of the most difficult years for markets on record, there was nothing but pessimism. In August, I wrote internally to our staff that “though the economic outlook has not exactly improved, some markets are in the midst of another raging bull market”.

Today, only 2 months later, the CNN Fear and Greed Index has swung from Extreme Greed in late July to Extreme Fear in early October and these 2 months the S&P 500 is down 6.6%, the ASX All Ordinaries Index is down 4.9%, and the MSCI All Country World is down 5.8%.

Fear and Greed Index

Source: CNN Business

The Fear and Greed Index seeks to capture the mood or sentiment in the S&P 500 market by gauging:

  • Market momentum (measured by the moving average of the index),
  • Stock price strength (measured by the number of stocks at 52-week highs),
  • Stock price breadth (measured by the number of stocks that are rising vs falling),
  • Options ratios of the number of investors betting on a market fall vs a market rise,
  • Market volatility, (measured by price fluctuations expected by investors, per the CBOE Volatility Index, or VIX)
  • Safe haven demand (measured by the 20-day performance of equities vs Treasury Bonds, which perform well in times of fear and uncertainty),
  • Junk bond demand (another measure of preference for safety, measured by the difference in yield between higher risk non-investment grade (or “junk”) bonds vs investment grade bonds).

In early October, only junk bond demand suggests an environment of Extreme Greed, all others are in Extreme Fear territory.

To chart the movement of the Fear and Greed Index is to tell the story of the market movement through the year. The year started in “Fear”, but by late February sentiment had already improved to “Extreme Greed” before falling to “Extreme Fear” in early March when US regional banks looked unstable. The Fear of a banking crisis gave way to AI-driven Extreme Greed, and remained there until late July, at which point bond yields started increasing and the US Federal Reserve, despite not raising rates, made it clear that rates would remain higher for longer. Even though the Fed has been saying this all year, the market finally began to believe them resulting in a savage selloff in markets to the Extreme Fear environment we now find ourselves in.

Other factors also likely played a role in the current tumult, with industrial action in the US auto industry, the possibility of another US government shutdown, student loan repayments being reinstated, and higher oil prices all combined with Powell’s comments.

Why spend so much time talking about this index? And why today? The answer is that while Mr Market has been as manic-depressive as ever in 2023, the companies inside the index (and our portfolios) have continued to run their businesses. They have continued to invest for the future. And they have continued to grow their profits (hopefully).

Normally we talk about multiples in this context, but the Fear and Greed Index gives a good second opinion. However, the two tend to move together. In times of optimism, stock prices will be bid up such that the ratio of share prices to their expected earnings will increase (the forward P/E ratio) and in times of pessimism will decrease.

The following chart shows how this plays out. The red bars denote the time when the Fear and Greed Index troughed inside Extreme Fear and the green bars when it peaked inside Extreme Greed.

Source: Oracle Investment Management, FactSet, CNN

What it shows is the futility of trying to time the market, because the mood of the market can turn on a dime and it will take prices with it. But it won’t take valuations. You might be asking “What’s the difference?” The difference is huge. “Price is what you pay, value is what you get”. So said Ben Graham to Warren Buffett, as quoted in the 2008 Berkshire Hathaway Annual Letter. In other words, the value of the business doesn’t change just because the mood of the market changes the share price.

We are often asked for our view on where markets are going. I think the Fear and Greed index would discredit anyone trying to answer that question with any seriousness. Who would have predicted at the start of the year that the collapse of Silicon Valley banks would cause an international banking crisis that would weigh heavily on markets? Some would, and I’m sure some did, but to call those who did a minority would be overstating it. And who would have predicted the release of ChatGPT would lead to an artificial intelligence bonanza? AI is not a new theme, and those who invested in it before 2023 did very well. But the timing of this AI-fueled rally was unlikely to be predicted by many. And finally, who would have predicted that the market would finally heed Fed chair Jerome Powell’s warning that higher rates are here to stay? Now I’m certain this was a larger cohort, but again, it would have been difficult to predict the timing of when this would occur.

My point is that these are not entirely unpredictable events. And some investors will have portfolios positioned ready for them. But all of them? And in order? If you had positioned a portfolio for one, then the other, then the other, you would have looked insane because you would have had to shift your portfolio between extremely bearish to extremely bullish several times within 9 months. And this is the key takeaway: to time the market successfully you not only have to get your exit right, you have to get your reentry right too. What is the point of getting a short-term sell call right only to miss the right time to reenter the position, only to see the price end up higher than when you sold?

It is better to be confident in the company you own and stick it out through the difficulties and obstacles. Not only will this help you sleep better at night, but you won’t be interrupting compounding with things like taxes and transaction fees (but that is a discussion for another day). Better yet, history shows that the best time to buy is when the market is in times of Extreme Fear. I could pull out some more well-trodden quotes like buying when there is blood on the streets or being greedy when others are fearful, but I will instead quote Morgan Housel from a recent podcast entitled Rules of the Money Game. Rule 23 is this:

“Past success always seems easier than it was because know how the story ends”.

He goes on to say that it is easier to quote Warren Buffett than to do what he does. What Buffett does is invest very dispassionately with a rigorous emphasis on business quality and strict adherence to company values. It is not easy to buy in times of market fear because there is always a reason the market is acting jittery. If you only want to invest in times when everything looks rosy, guess what? You will pay a premium for the privilege.

In times of fear, it is all too easy to agree with sentiment and sit on your own because the market may go lower. In all likelihood, it will. But to invoke a Bill Ackman maxim, the lowest average cost wins. Buying in times of fear may lead to short-term loss, but greatly increases the likelihood of long-term gain because you are buying when stocks are in the proverbial bargain bin.

Mr. Market is currently in quite the mood and our response is as follows: we will continue to do what we always do. We will be responsible stewards of your capital, with which you have entrusted us. When the market presents good opportunities, we will happily take them, but we won’t be beholden to Mr. Market’s emotional state and we won’t be following the madness of the crowd just because sentiment has shifted, because eventually, it will shift again.

Written by Luke Durbin
Lead Portolio Manager
Oracle Investment Management
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Important information – Oracle Advisory Group makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.
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