Sentiment Indicators and Technical Indicators turn Bearish:
Both sets of Indicators turned Bearish, indicating markets are not accurately pricing-in risk. Technical Indicators reached the lowest levels since early 2011. Sentiment Indicators have been Bearish for months though we (at the Socially Responsible Investing website) have seen worse levels (see chart). However, the combination of both Sentiment and Technical Indicators turning Bearish is what motivated us to publish this warning.
We believe now is a good time to take profits and adjust portfolio tax losses against capital gains. There is a high probability for the market to rise between now and January due to seasonal factors. For example, tax-loss selling usually ends by mid-December (maybe earlier this year as investors worry over changes to tax rates) and employees typically add to 401K/IRAs in January.
However, our charts are measures of risk and we believe risk is high, despite what the markets decide to do. Risk is high, not only for Equities but other investments/vehicles including commodities (oil, etc.) and High Yield corporate bonds. The combination of a near-record high level of bond issuance, record-low bond yields and use of covenant-light structures give us further pause.
Markets are not pricing-in fundamentals. We believe that markets are efficient most of the time, but not all. Presently, markets are not pricing in the U.S. Fiscal Cliff (deadline: 12/31/12). Nor is it pricing in a resurgence of the Euro-Crisis. While we agree that certain countries (Ireland) and the European Central Bank ("ECB") have made efforts to contain the Crisis, the fact is that the large "core" Euro-Zone countries (e.g., France, Germany) are only now witnessing slowing economic growth. We believe risks will shift from the periphery to the core Euro-Zone countries as the ECB continues to aggressively support banks through cheap loans (i.e, more debt!) and sovereign bond purchases. A more recent, but not executed proposal would be to create a Fiscal union in the Euro-zone, which of course would be steered by the French and Germans. We are not so sure the Italians would like that!
Sentiment Chart: It became moderately Bearish when the index declined below 5 earlier this year. (Note: Refer to Background Information (below) to determine how we read the indicators.)
Technical Chart is below. It became Bearish recently, as of 12/21/12. We consider Bearish readings those that are below -2%.
As a long-term investors, I (Dominic Lombardo) believe the time for Socially Responsible Investing is now…right now. Long-term investors are not concerned over the current level of the stock market and whether the Market's going to rise or fall the next day.
I propose investors be "fully invested" in equities most of the time. Being "fully-invested" is different for different people depending on age, risk tolerance, etc. As a Heuristic, I suggest being 75% long equities as a "base-case" level. The remainder would be invested in bonds, real-estate, hard assets, and alternative/exotic investments (e.g., natural gas, platinum, rare-earth anyone?).
With that being said, there are certain times that are better to invest in the market. Rather than choosing tops and bottoms based on certain fundamental criteria (e.g. price to earnings ratio), I have developed two Market Timing Indicators. These indicators help me maintain objectivity with regards to my investment positions, as I have no influence on them. They were designed during late 1992 and have been updated weekly since.
The two major indicators are:
1. Sentiment: based on human behavior, and supported by theories backed by Behavioral Finance.
2. Technical: which measures market breadth, or underlying strength in the broad market.
These indicators are used to obtain my Portfolio's Investment Position. Note, they do not know, or represent market levels. They are measures of perceived risk, especially the Sentiment Indicators. I have often taken mental notes of how everyone seems to clamor to buy things when their expected rate of returns are minimal compared to their inherent risks.
This website will include three simple colored (traffic) signals. Green for "Buy" (i.e, low-risk levels) which means allocate your portfolio to a fully-invested equity position. For me, that's about 75-80% invested, but it could be lower for a more-risk adverse, or retired individual. Yellow, means caution, risk levels rising. Red means "High-Risk"; investors should reduce their investment positions to conservative levels perhaps 30-40% equity. The remainder could be in treasuries, gold, high-grade corporate bonds, etc.