Risk Appetite

FEAR vs. CONFIDENCE

The high-yield ETF (JNK) pays a 6.02% dividend.  The long-term Treasury bond ETF (TLT) pays a 3.04% dividend.  The 6.02% dividend is tied to instruments that have a higher risk of default.  Defaults typically increase during recessions.  The ratio JNK:TLT ratio below says a lot about the market's current perception of the economy and default risk.

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The same "we are not overly concerned about a recession and rising default rates" look can be found in the high-yield (JNK) / intermediate-term Treasury (IEF) ratio.

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The growth-oriented small cap (IWM) to more-defensive-oriented long-term Treasury bonds (TLT) ratio also tends to side with economic confidence rather than economic fear.

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THE BATTLE OF THE BULLS AND THE BEARS

When markets are in an indecisive trading range, it can be difficult to get a handle on who is winning the ongoing battle between the bulls and the bears.  This week's video provides some longer-term insight by comparing the NASDAQ (QQQ) in 2018 to the major peaks in 2000 and 2007.  The video also examines small caps (IJR), energy (XLE), global stocks (VT), MLPs (AMJ), growth stocks (VUG), and dividend stocks (DVY). 

FEAR OF AN IMMINENT RECESSION?

Since consumers tend to shy away from discretionary spending during recessions, but still buy toothpaste and soap, the XLY:XLP ratio tends to fall as economic fear increases.  In the present day, the ratio tends to side with confidence over fear (see below).

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MORAL OF THE STORY

While there is nothing magical about the ratios above, they do contribute to the weight of the evidence.  Presently, the weight of the evidence continues to slant in favor of economic confidence relative to economic fear.  How long that will be the case falls into the TBD category, which is why under our approach, it is important to maintain a flexible, unbiased, and open mind.

S&P 500 Retracements

CORRECTION OR BEAR MARKET?

The answer to the question is this a normal correction or the start of something much worse will only be revealed over time.  However, there are numerous ways to gain a better understanding of the probabilities, including Fibonacci retracements.

It is relatively common for an existing bullish trend to retrace or give back 38.2%, 50%, or 61.8% of a prior A to B bullish move.  The S&P 500 had a multiple-week pullback that began in early March 2017.  The market found its footing near point A in the chart below and rallied until late January 2018 (point B).  The S&P 500 found support from buyers near the 61.8% retracement on February 9, 2018.  Since then, price has consolidated above the 61.8% retracement level. 

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MORAL OF THE STORY

Even if we only look back as far as March 2017, the current pullback looks like a normal retracement within the context of an established and ongoing long-term bullish trend.  If the bullish trend remains intact (TBD),  it is logical to expect the S&P 500 will eventually make a higher high above the January 2018 peak (point B).  Time will tell.

THE PSYCHOLOGY BEHIND 'THIS WILL END BADLY'

The dot-com bust (2000-2002) and the financial crisis (2007-2009) caused an incredible amount of stress in many American households; a fact that is still impacting investor psychology in today's markets.  If you were 7 years old in 1997, you were 23 when the S&P 500 was nearing the 2000 and 2007 highs in 2013.  If you were 55 in 1997, you were 71 in 2013 (see chart below).

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Based on the 2013 chart and demographics shown above, it is easy to understand why it was common to hear "this will end badly".  Anyone between the ages of 23 and 71 in 2013 had two "this ended badly" memories fresh in their minds. 

2018:  28 TO 76 YEAR OLDS HAVE PAINFUL MEMORIES

If we fast forward to 2018, the table below shows the vast majority of 2018 market participants were between the ages of 7 and 55 in 1997.  They experienced both the dot-com and financial crisis bear markets.  Thus, the vast majority of market participants in 2018 still have an emotional connection to "bull markets end in a painful manner".

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WHAT HAPPENS IF WE LOOK FURTHER BACK IN HISTORY?

We all know stock market history is not confined to the 1997-2018 period.  Is it possible our perceptions of the present day market would change if we reviewed today's market in a much longer (1926-2018) context?  You can decide after watching this week's video.