What Do We Do Now?
The S&P 500 closed on Tuesday, January 25, 2022, at 4,356.45, almost 9% lower than it opened on the first trading day of 2022. It is natural for investors to feel worried, anxious, concerned, afraid, or perhaps even excited when they think about recent stock market performance. However you feel, it is important not to react based on emotions. Some will see this as an opportunity to buy when stocks are on sale. Others will feel fearful and perhaps want to sell. Before making any decisions, recognize and acknowledge your feelings. Then, consult your financial plan to determine if it is necessary to make a decision. Here we look at two measures of current public sentiment, followed by what we believe at Hurlow Wealth Management Group.
AAII Member Sentiment
The American Association of Individual Investors is an independent, nonprofit organization that offers education, information, and research to assist individuals in learning how to manage their own assets effectively. Every week, the organization asks its members, "What direction do you feel the stock market will be in the next six months?" For the week ending January 19, 2022, the majority (46.7%) felt bearish, while 32.3% felt neutral, and 21% were bullish about the near future. So are the bearish investors correct, or are they reacting to the noise of the financial media?
Let's look at history. On February 20, 2020, 40.56% of AAII members surveyed felt bullish about the market, compared to 28.7% bearish, the same day the stock market crashed due to the global pandemic. A few months later, on May 7, 2020, 52.66% felt bearish about the market, and only 23.7% felt bullish. We were already one month into the new bull market on this date. Based on these two data points, it would seem those individual investors tend to be more reactive based on their emotions. However, we don't know if those surveyed actually made investment decisions based on their sentiment.
Fear & Greed Index
Every day, CNNMoney's Fear & Greed Index measures the emotional pulse of investors using the seven indicators below.
- Put and Call Options Volume: High call option volume indicates more investors are looking to buy stocks, while high put option volume would mean investors were looking for options to sell stocks. This week's option volume indicated investors made more bullish bets in their portfolios. Put option purchases lagged volume in call options by 87.72% over the past five trading days (ending January 25, 2022), signaling extreme greed on the scale.
- Junk Bond Demand measures the risk premium of low-quality junk bonds. The higher investor greed sentiment, the lower the spread is over safer investment-grade corporate bonds. The yield spread is now only 1.57 percentage points, indicating that investors are bearing more risk for less reward.
- Stock Price Breadth, as measured by the McClellan Volume Summation Index, shows whether the New York Stock Exchange's trading volume trends are declining or advancing. Over the previous two months, an average of 13.97% more of each day's volume traded in declining issues than in advancing issues, a neutral rating.
- Market Volatility measures the investor's concern about the near-term values of their portfolio as indicated by the CBOE Volatility Index (VIX) and the 50-day moving average. It currently shows extreme fear at 31.16, almost 50% higher than its 50-day moving average.
- Stock Price Strength: The number of stocks hitting new highs compared to those hitting new lows. Current 52-week lows exceed the highs, an indication of extreme fear.
- Safe Haven Demand is measured by the percentage of stocks outperforming or underperforming bonds. During the last 20 trading days, bonds beat stocks by 6.73%, signaling extreme fear.
- Market Momentum measures the S&P 500 and the 125-day average. Extreme fear dominates this index as the S&P 500 dipped more than 4.22% under the 125-day average.
To understand what emotion is driving right now, the seven indices are weighed equally between 0-100, zero being extreme fear, while 100 is the highest on the greed scale. Based on the factors above, the scale measured a fearful 37 after the market closed on January 25, 2022.
What We Believe
At Hurlow Wealth Management Group, we accept that we can't control the stock market, but we believe that over time capitalism will produce returns for investors. Here is a summary of our beliefs about the stock market:
- The world is not predictable - The global financial markets are highly complex, and thousands of variables drive performance. Consistently predicting outcomes for each variable is not possible. Nobody predicted the COVID-19 pandemic. But we've seen plagues in the past; we've also seen wars, terrorist attacks, bubbles, inflation, and changes to the tax code. The markets will react however they do, and we respond as appropriate, but we don't try to predict.
- The financial media is noise – The media is incentivized to keep you tuned in to their station, renew your subscription, or click through their website. To do this, they promote fear and greed. They need to over sensationalize the news because their goal is to get attention and sell advertising. In general, the financial media will not help you become a better investor.
- Capitalism produces returns for investors over time – Our economic system has a long time-tested history of growing profits and returns for investors. Investors take risks in the short term to expect higher returns in the long term.
- Focus on what you can control – For a better investment experience, it is essential to understand the actions you can control and what is out of your hands.
What can you control?
- Taxes and costs: We can control the investments we choose for various accounts. We manage all the accounts collectively as an all-encompassing target portfolio for you, so we strategically hold more tax-efficient investments in our clients' brokerage accounts and less tax-efficient investments in qualified accounts. In addition, we will load Roth IRAs (if applicable) with the most aggressive asset classes, as all of that growth is forever tax-free. Also, we choose funds that have low expense ratios. We build portfolios that optimize tax-favored accounts, and we use mutual funds with below-average costs.
- Choice of Investments Based On Evidence: Our investment strategies are backed by academia and have a long track record of success. We filter through the noise, misinformation, and emotion to make reasoned investment decisions.
- Behavior: We help our clients make disciplined investment decisions while avoiding emotions and cognitive blind spots.
- Risk Tolerance: We help our clients determine the appropriate amount of risk based on goals and needs, as well as comfort and experience with down markets.
How Much Stock Exposure?
The formula we use to determine your risk level and exposure to the stock market is threefold, need, ability, and willingness.
Need is calculated as the minimum return to accomplish your goals based on your financial plan, objectives, and future cash flow needs.
Ability is factored based on when you need the money. As risky assets need a time buffer to avoid selling in down markets, we generally recommend keeping seven years of withdrawals in bonds.
Willingness depends on your personal preference and ability to sleep at night during market turmoil. Based on your age and time horizon, you might be able to take higher risk, but if short-term portfolio declines make you feel uncomfortable, your willingness may be lower than your ability.
What Do We Do Now?
We consistently monitor the markets looking for opportunities to take action and rebalance our portfolios. When various sectors within the overall stock market rise or fall, we evaluate to see if the drift is within a tolerated percentage. If the allocation is more than 20% from its target, we realign by buying or selling investments. The chart below shows that 20% represents the optimal rebalancing bands based on academic research.
Balancing your investments with your emotions can be tricky on your own. For two decades, the Hurlow Wealth Management Group has helped clients identify appropriate investing strategies by evaluating income needs, ability, and willingness to take risk and then creating and implementing personalized financial plans. This process allows individuals and families to find clarity, feel confident, and achieve comfort through appropriate risk management associated with investing. If you need help, schedule a FREE consultation with one of our professional investment advisors to get started building your financial plan and investment strategy.