Investor Psychology has Weakened

This week our Psychology Composite moved to P5.  There is little doubt the news is getting better, and we're sure that Obama is glad as the election season heats up.  According to some studies, the level of consumer sentiment or the Administration's approval rating in March has been fairly good at predicting the incumbent's chance of reelection.  But to get off the subject of politics, and back to what really matters...

Let's review this "tug of war" that often has implications for at least the short-term nature of the stock market, between the improving economic conditions and the weakening infrastructure of the Psychology Composite, or to use the market's language, the Wall of Worry.  As you recognize, optimum buying junctures occur when the fear is high, and selling points generally occur when emotions get a little too optimistic.  Let's show you just two examples of recent trends. 

To begin with (a chart that we often share), the stock market has been very overbought, meaning the upside action has reached extremems as measured from the ongoing trends.

Click on the image above to view a larger chart.

In the chart above, you can see that the blue line (McClellan Oscillator) reached that extreme, and it was confirmed by the orange line (21-Day Oscillator).  The correction from those extremes has already begun, but in most cases the 21-Day Oscillator has to recede down into oversold territory (under -50) before sufficient "rest" has been restored.

At the same time, many of our technical indicators of fear and greed have moved into the "too much greed" category.  The AAII Sentiment Survey is one example.

Click on the image above to view a larger chart.

So today we'll reiterate that from a long-term perspective, the very favorable conditions of Monetary and Valuation continue to tell us to focus on the positive long-term outlook.  As we look at the short-term, however, history tells us that the short-term conditions are not nearly as positive at this juncture.

Don Hays

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