Probability And Investor Sentiment Suggest Stock Markets Are Vulnerable

A theme of our commentary over the past few months has been the unattractive risk/reward prospects currently offered to investors by global capital markets. Two major factors in our analysis are investor sentiment and probability, both of which are reflected by the chart below.

The S&P 500 is currently more than 2 standard deviations (std) (almost 3) above its mean. Being 2(std) away from the mean occurs less than 5% of the time, while 3std occurs less than 0.3%. The S&P is stretched and vulnerable to retracement.

A useful measure of sentiment is the 10-day moving average of the equity put/call ratio. The ratio is currently at its lowest level in more than 5 years and more than 2 std away from its mean. Investor optimism is now at higher levels than that seen during the internet bubble era.

We live in an era that will produce both significant risks and opportunities for investors. Each month we discuss the major factors affecting global markets and our strategies to maximize risk/reward.

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