MOTIVATING FACTOR
Investors looking to capitalize on market slump may be keeping it afloat.
The stock market’s lack of response to the u.S. government shutdown and the upcoming debt-ceiling deadline has surprised many.
Perhaps pundits are to blame for pointing out that the market has actually moved higher during previous shutdowns, but we think there is more to it than that
Specifically, there are a lot of investors, professional and retail alike, who missed out on the stock market recovery early on as they were paralyzed from the shock of the collapse in 2008 and early 2009. The fear of missing out on the next move higher can be a very motivating factor.
A famous 1995 study by the Harvard School of Public Health asked students and faculty which of the following two options they preferred: being paid $50,000 per year while others around them make only $25,000; or receiving $100,000 per year while everyone else makes $200,000. under both options the price of goods and services stayed the same.
Surprisingly, 50% of the participants in the study picked the first option, choosing to forgo $50,000 per year in or- der to avoid earning less than their neighbours.
This fear of making less or losing more than your neighbours applies equally to the investing world. consequently, many end up buying the market tops and selling at the market bottoms.
In the current environment, those with excess cash positions have underperformed those around them and we believe they are finally capitulating, potentially at the wrong time and for the wrong reason.
As a result, negative news events have suddenly become positive catalysts pushing investors to step in for fear of missing out on the next move higher. Many are buying the dips expecting a material gain upon the resolution of the current situation in Washington.
Or, as the old trader saying goes: buy on rumour, sell on fact.
For example, take a look at the intra-day action last week. Markets sold off every morning on the open and, like clockwork, the buying began, bidding the markets up to close higher. Lather, rinse, repeat.
However, there is an important difference from previous shutdowns that, in our view, pundits and investors conveniently seem to be disregarding. That is, the S&P 500 has al- ready rocketed to near all-time highs and complacency has reached pre-financial crisis highs.
Aside from the shutdown and potential debt default, investors don’t seem too worried about any drag looming on corporate earnings that account for approximately 10% of GdP.
We’re about to get a look at Q3 earnings, which kick off this week with nine companies set to report. In our view, expectations of 4.5% year-over-year growth are quite high considering nearly two-thirds of companies have reported negative guidance, according to recent S&P capital IQ analysis. This level of negative surprises is also above the 10-year average.
In the end, we wonder if any disappointment will just provide another excuse to buy the dips. consider that last-quarter earnings only expanded 3% over the previous year while the S&P 500 rocketed nearly 20% over the same period.
There are more than a few lessons to be learned from what is currently transpiring in the market.
The most important one is not to try to time the market by taking big bets with your cash positions.
We always recommend staying invested for the longer term and taking advantage of periods of high complacency to hedge out one’s positions against risks whenever they are clearly not being reflected in the market.