Attempting to forecast or time the stock market is a losers game given that many studies demonstrate the significant negative impact of missing out on even a few good days in the stock market. So, what follows is strictly for informational purposes and not designed to spur an investment decision.
A number of metrics suggest that investors are very much in a “risk-on” frame of mind. First, as reported in my June 17th post, Maxed out on Equities?, equity exposure for the average investor is at an all-time high, an indicator that has generally been inversely correlated with future returns. Second, stocks are very richly priced as demonstrated by the Cyclically Adjusted P/E ratio or CAPE on the S&P 500 which is currently in the 99th percentile of historical experience. Third, peaks in the usage of margin debt tend to coincide with peaks in the stock market. The following graphic displays cash balances less margin debt and you will note that the negative balance is at a record level indicating extreme leverage.
In addition to margin accounts, another source of leverage is the purchase of leveraged ETFs which magnify the return (either good or bad) on an underlying investment portfolio. The next chart shows the assets invested in these funds and you will note that they have increased roughly four-fold since 2020.
A high octane version of these ETFs produces a leveraged return on a single stock. Bloomberg recently reported that investors have contributed $22 billion to them. Another good indicator of investors’ mentality is the junk bond spread which measures the yield on lower quality bonds versus those on U.S. Treasury issues. A narrow spread suggests complacency whereas a wide one indicates extreme fear. The spread is currently in the bottom 20% of historical experience indicating that investors are very comfortable with the state of the world. Finally, a popular medium for speculation is Bitcoin whose price has increased 60% since early April.
So, don’t panic but it probably does make sense to lean toward quality and try hard to keep your animal spirits under control.