Too Much Confidence?

There are times when you have to be a contrarian to invest successfully.  Other times, the herd is correct and you need to join them. In a bull market, the overconfident investors are correct.  They are right.  Selling because people are optimistic in a bull market is the wrong move and you should buy from those that are temporarily scared.  On the flip side, a bear market fear is the right mood.  Those who are selling because they are scared is correct.

On the chart below, I have my crazy investor indicator which I post every once in a while.  The middle line is the actual indicator and the bottom line is the S&P 500.  You can see that being scared (middle line at the top) in the fall of 2008 and selling was the right move.  It was not correct to buy the dip as you would have done in a bull market.  Conversely, the summer of 2009 produced a very confident mood on the part of investors (middle line at the bottom) and the market continued higher.

It’s been interesting the last few weeks as the S&P 500 has moved sideways in a tight range the Crazy Investor Indicator has been pretty erratic.  If you squint your eyes, you can see the very right side of the graph shows that we have a lot of confidence on the part of investors (similar to the May June time frame) right now.

This is telling me one of two things:  Either this is a great time to sell because in a struggling market you sell to overconfident people.  Or, things are so good that we’ll simply move higher and the overconfident people are correct.  Because I’m giving you a 50/50 scenario, that means my portfolio is heavy on cash right now.  I need more of an edge than I’m getting.

The internals of the market haven’t been bad.  They’ve been pretty mediocre but I see nobody willing to sell at these prices.  That’s encouraging.  On the negative side, the demand isn’t there either.  It’s a stalemate.  So, when I see overconfident people and a 50/50 scenario, I’m cautious.

There are still plenty of things to buy right now but make sure you have an exit strategy.  I think the turn of the calendar might bring some extra volatility simply because periods of no volatility are usually followed by more than usual volatility.


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