It’s time to take a reading of where we are on the Fear and Greed curve. If we want to be better investors, it is critically important to take stock of where we are in the cycle from time to time.

Fear and Greed Investment Cycle
Source: Investment Postcards Blog

This week, I am borrowing the chart shamelessly from Prieur du Plessus who runs a very informative investment blog from his base in Cape Town. If you would like to receive his thoughts, he offers a free email subscription (follow this link).

The Fear and Greed Cycle is a classic and has been around for decades at least.

What is a classic?

According to Mark Twain, a classic is “Something that everybody wants to have read and nobody wants to read.”

OK, many of the “classics” we were forced to read in school were pretty dry but that’s not the reason we ignore the Fear and Greed cycle. We ignore it because it reminds us that our emotions play a strong role in our investment decisions. When the market is low, so are our emotions and we fail to buy (or worse, we dump at the bottom). When the market is at the top, our emotions are bubbling over and we fail to sell (or worse, we buy more). Since this is the core argument behind the IRP System, we won’t belabor the point here other than to say that we believe emotions are the key driving factor behind price movements.

So where are we today?

Globally speaking, we are in the middle of the left hand side of the curve, somewhere in the region of Caution. Some markets are more confident than others but there are many investors who still bear the emotional scars of the Global Financial Crisis. We are edging in on Enthusiasm but we are a long way from Conviction.

One of the interesting features of this recovery is the unevenness of it. Because the Global Financial Crisis was largely a G-7 event, the normal order of recovery has been scrambled. Usually, the global heavyweights in the developed markets lead the market recovery followed by smaller caps, emerging markets and exotic themes. This time, the financial markets were led out of the woods by the BRICs (Brazil, Russia, India, China) economies that were able to sidestep the worst of the recession. Countries like Poland did extremely well by not falling into recession at all. So, our normal “rules of thumb” may be a bit stretched but the emotional state driving investor decisions remains the same. Therefore, when we point out that US Consumer Discretionary Spending stocks look promising (VCR & XLY) while China (FXI) Brazil (EWZ) and India (EPI) have come off the boil, it should be noted that market sector leadership was very different this time around.

So what can we expect?

Given the ferocity of the bounce from last March, it is tempting to conclude that this trip up the left side of the curve will happen very quickly. In economic terms, that would be anticipating a double dip recession or W shaped recovery. That outcome is still quite possible but we are preparing for a longer, messier, uneven recovery similar to what we have experienced over the last 12 months. Economically, this more likely but messier scenario would see growth returning in fits and starts around the globe. On the Fear and Greed curve, it would leave us struggling between Caution and Optimism for the next 12 to 18 months.

What should we watch out for?

One should be on the lookout for signs of hubris and in the case of China’s recent property bubble and the potential bubble that has built up in Sovereign Debt, those signs of overconfidence are already here. Bubbles in one or two asset classes are not a sign of the end and with all the stimulus cash sloshing around the global economy, it is to be expected. However, when the majority of asset classes look bubbly, it will be time to look for the exit. We are not about to embark on a 20 year bull run in asset prices, not at these starting levels anyway.

What looks good this week?

This week, our international portfolios are still positive on Emerging Europe (GUR/GMM), India (EPI) and Japan (EWJ). Our mixed US/International portfolios are positive on Consumer Spending (VCR & XLY), Biotech (XBI), Pharmaceuticals (XPH), US Small Caps (VB, IJR & IWM) and Homebuilders (XHB).

New ETF Pages…

We are building up our ETF information pages (starting with AWCI) so please click through and check them out. Any suggestions (ETFs you would like to see, different presentation or any other comments) would be most appreciated.

Filed under: ETFInvestment ProductMarket Comment

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