Extreme bullishness, overbought stocks, overvalued equities, and rising yields have overtaken the US financial markets over the past two weeks. The VIX, which measures the overall fear of investor's sentiment is trading below 18, which indicates investors are becoming complacent and believe macro events are not of concern. In this type of market sentiment rarely do we see equity appreciation to be sustained in the short-run nor do we see asset price increases without a significant interim correction. I am becoming increasingly concerned with investor's lack of awareness concerning the potential macroeconomic and geo-political risks that are present within the global financial landscape. One of the most concerning aspects of market sentiment is the so-called Smart /Dumb Confidence Index, which currently indicates that 'Dumb" money is at an all-time high. This index was created by Russell, which tracks institutional buying vs. retail buying. Notice what happens when the spread between the Smart vs. Dumb money is at extreme levels. I anticipate we should see this index correct itself sometime over the next quarter, and would not be surprised if it happened sooner.
Since this summer I have been very concerned with the lack of risk management control measures being convey by the FOMC, Wall Street Banks, and the US Federal Government. Do not be fooled by the overzealous nature of buy side investment management firms that continue to promote overvalued, overbought and extreme bullishness within the equity markets. Eventually the speculative nature of the markets will correct significantly, and those who are not protected will once again get burned by buying too high and of course selling low. Upside returns in the short-run are possible and probably likely, but we will remain hedged until market valuation, overbought equity prices and over-bullishness subsides from the financial markets.
Final thought: The US economy seems to be on a modest upward trend, which is positive longer-term. Unfortunately, equities are being priced for extraordinary growth over the next 12 months. I am becoming more confident that over the next 18 months a double-dip recession is unlikely. Nevertheless, equity prices need to correct, before I will get excited about sustainable future equity price appreciation. The markets are extremely risky at the present level.
