Fear and Greed Hit High in the Markets

by: Barry Ritholtz

We have mentioned the astute work of James Montier previously, and suggested his Fear & Greed index should replace Citibank's silly Euphoria measure in Barron's Trader column.

Montier is a research analyst at Dresdner Kleinwort in London, and is the author of Behavioural Finance: A User's Guide. There is a good biographical sketch of Montier as an iconoclast/maverick here.

Recently, his F&G Index hit an all-time high. This was noted as yet more evidence that "investors’ euphoria is truly out of control.” Of course, he wryly adds, “this warning is likely to be about as effective as yelling ‘cliff-edge’ to a herd of thundering lemmings.”

fear_greed

Marketbeat noted a few details of this sentiment index:

The F&G index, compiled by Dresdner Kleinwort, is a risk-adjusted price momentum measure comparing global equities (as gaged by the MSCI World Index) to global bonds (represented by J.P. Morgan Chase’s index). The gauge has typically traded between +1 and -2 since its inception in 1986 — but was as low as -3 just four years ago, a sign that “the end of the world is nigh,” and therefore a time to buy stocks and sell bonds. But as the market has turned upward in recent years, the index has shot up above +2 into the “irrational exuberance” area, a sign to sell equities and buy bonds.

Still, he suggests that “the prudent investor should be shipping out beta and junk, and buying quality defensives.” Even better, Mr. Montier says, “holding cash seems like a good idea,” noting that U.S. mutual funds currently have a mere 3% to 4% in cash. To paraphrase Warren Buffett, he says, “holding cash is painful, but not as painful as doing something stupid."

Note that this tends to be an early warning system, and is not a precise (hours, days) timing measure. Think of it as a 90 day warning of trouble potentially heading your way.

Source:
Fear and Greed In Markets
David Gaffen
WSJ, February 22, 2007, 3:26 pm
http://blogs.wsj.com/marketbeat/2007/02/22/fear-and-greed-in-markets/

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