Too Much Confidence?

I know it seems strange to say there is too much confidence right now.  But, based on my indicator which measures fear and confidence, we are the highest levels of confidence since the summer of 2008.  How can there be confidence right now with all this bad news?  I think investors are somewhat numb to bad news and numb to bad data.  So, it’s not confidence, it’s simply the panic waring off.  In addition, several months have passed since this crisis first started.  At the end of the day, it doesn’t really matter why they are confident.  What matters is whether or not that translates into higher equity prices or lower equity prices. 

In a bear market, confident investors are wrong and should be sold to.  That means selling your holdings and/or going short the market.  There are always bear market rallies where there is a temporary respite in fear.  That’s normal.  You can see from the chart below that we are certainly seeing a lot of confidence right now.  The middle line is my indicator which goes from very scared (October 2008) to overconfident  (May 2008).  The lowest line is the S&P 500 since the summer of 2007.  I’ve circled four times where confidence has been really high.  They were all great times to exit stocks.  Unless you think this is a new bull market, this may be an excellent selling point. 


So, why am I not running out and shorting?  For a few reasons.  First, the first step is simply to protect my portfolio by either hedging or placing stop losses underneath them.  This will insure I’m protected if this was all just another bear market rally since March 9th.

Secondly, there is always a chance this is a new bull market.  As you know, I am not seeing any signs that that is the case.  But, it’s still a possibility.  If that’s the case, overconfident investors are correct.  The chart above shows just the past couple of years.  If I was to go back even further, you’d see that there have been a few times where just because investors are confident, that didn’t mean the market went down.  Quite the contrary.  It actually kept going up.  Overbought markets can continue to rise.    Therefore, we need to take the data above and use it in conjunction with tons of other data to determine the next course of action.

For the time being, I’m building some cash and waiting for a breakdown or a resumption of the rally.  Too early to tell but this is a red flag we need to pay attention to.

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