The Investment Scientist

Archive for March 2008

Investor sentiment is at its lowest since 1990 and second lowest since the American Association of Individual Investors (AAII) sentiment indicator began in 1987. On 2/7/08, the 8-week moving average bull/bear spread reached the low of -25% and has since hovered below -20%. What does it mean for investors that the bull/bear spread stands at -25%? And what is the bull/bear spread?

Are you bullish, bearish, or neutral?

That’s the question asked by the AAII who has been conducting weekly market-outlook surveys of its members since 1987.

The bull/bear spread is the bullish percentage of the answers minus the bearish percentage of the answers. For instance, if 30% are bullish, but 50% are bearish, then the bull/bear spread would be 30%-50%=-20%. Since investor sentiment is very votalile, the 8-week moving averaging is used to smooth out the kinks. The AAII has 20 years of data with which we can study the relationship between investor sentiment and stock market return.

Current low investor sentiment is significant because there were only six instances (excluding this one) when it was below -15%. And only two instances when it was below -20%.

How does bearish investor sentiment relate to stock market return?

I used the small sample of six prior occasions when the bull/bear spread was below -15%. I then studied the subsequent one-year returns by the S&P 500 and the Fama/French Small Cap Value Benchmark Portfolio. The result is displayed in the table below.

Time (8 weeks ending on ) 8 week MA bull/bear spread S&P 500 one year return Small Cap Value one year return
11/2/1990 -37% 25% 46%
2/7/2008 (this time) -25% ?% ?%
10/23/1992 -21% 12% 40%
3/13/2003 -18% 40% 82%
7/2/1993 -15% 0% 11%
7/20/2006 -15% 23% 23%
3/16/1990 -15% 9% -2%
Average -20% 18% 33%

Data sources: AAII, Kenneth French data library

History shows that the worst decline is over once the indicator shows a reading of -15% or below.

One-year returns for the S&P 500 ranged from 0% to 40%, while those for the Fama/French Small Cap Value Benchmark Portfolio ranged from -2% to 82%. To the extent history repeats itself, the risk rewards of stock investing is heavily skewed toward rewards.

Warren Buffet put it best when he said: “Be greedy when others are fearful.”

6/22/2007 After Bear Stearns’ hedge funds blew up, Jim Cramer said on CNBC’s Stop Trading:

Buy Bear Stearns! …fund problem won’t spill over.

8/3/2007 According to StreetInsider, Jim Cramer made comments about Bear Stearns, saying he thinks the company shouldn’t have held a conference call to put more bad news into the market …

2/11/2007 Jim Cramer made his Lighting Round bullish calls:

I think you stick with Bear, I think this Justice Department thing will be cleared up.

3/11/2008 Before Bear Stearns’ collapse, Jim Cramer:

Bear Stearns is fine … Bear Stearns is not in trouble. Don’t be silly … Don’t move your money.

3/17/2008 After Bear Stearns’ collapse, Jim Cramer:

I said the common stock was worthless on Friday.

Chinese stocks are hot. Taiwanese stocks are not. That’s about to change.

Taiwan will hold its presidential election on March 22nd. Barring an extraordinary electoral surprise, Ying-jeou Ma, the candidate from the pro-business and less China-averse KMT will win the election. (Currently Ying-jeou Ma is leading with 63% in Taiwan’s political futures market.)

The relationship between China and Taiwan is best seen as a broken marriage. China wants to reconcile the rift on its own terms, and threatens consequences if that should not happen. Taiwan, on the other hand, suffers from multiple personality disorder. One part of it wants an outright divorce. The other wants to stay separated with the option of eventual reconciliation.

For the last eight years, Taiwan has been ruled by a president who favored outright divorce. His government has been responsible for hampering economic interactions between China and Taiwan. As the result, Taiwan’s economy languished exactly when China was making a great leap forward. Taiwanese stock market is basically where it was eight years ago. But many emerging economies have seen their stock markets double or even triple during that time. It’s likely we’ll see a catch-up rally once the dust settles after the election.

Even a surprise win by DPP candidate Frank Hsieh wouldn’t be that bad for Taiwanese stocks. He’s seen as a pragmatist within his party. Rhetorically, he would still want the divorce. Economically however, he wouldn’t mind sleeping with China.

Inclusion, if you want a small piece of China in your retirement investment portfolio, you can still have it cheap with a Taiwan ETF (EWT) or some Taiwan ADRs.

Related symbol: EWT
Disclosure: I own EWT

Jim Cramer:

What I’m saying is that there are bargains right now, there are stocks right now that if you’re shrewd enough, you will be able to buy them at the opening today and you’ll make money in a year from now.

It has been a year since Jim Cramer made his many picks in Mad Money Lighting Round last January. Undoubtedly, many people followed his advice buying his stock picks. To get an idea of how much money they made, I decided to do a little research.

The research is straightforward enough. I looked up the recap of Mad Money Lighting Round at and tabulated Jim Cramer’s bullish and bearish calls. I then calculated one-year returns from the second (market) day he made the calls.

    Bullish: If a bullish call has a one year return higher than that of the S&P 500, it is a right call. If not, it’s a wrong call.
    Bearish: If a bearish call has a one year return lower than the S&P 500, it is a right call. Otherwise it’s a wrong call.

I calculated the accuracy of his calls by this formula: Accuracy = right call/all calls. I also determined what return a loyal Cramer follower would have made if he/she had bought all of his bullish calls and sold all of his bearish calls.

In January of 2007, Jim Cramer made a total of 194 bullish calls and 123 bearish calls. Out of the 194 bullish calls, 60 are right calls. Out of the 123 bearish calls, 53 are right calls. The accuracy of Jim Cramer’s bullish calls is 30.93% and that of his bearish calls is 43.1%. The combined accuracy is 35.6%.

During the one-year period after Jim Cramer made his calls, the S&P 500 fell an average of 3.72%, his bullish calls on average fell by 3.33% but his bearish calls actually increased by 3.11%.

The table below shows Jim Cramer’s calls on 1/3/2007 and their subsequent one year returns. You may request a complete report of all of his January 2007 calls from MZ Capital.

Date Bullish Calls 1y return   Bearish Calls 1y return
1/3/2007 CVX 38.46%   XOM 31.17%
  MPEL -50.53%   MOT -20.97%
  NYX -11.22%   NOK 86.41%
  EBAY 3.96%   HSY -20.94%
  SPG -14.71%      
  NXG -1.89%      
  AUY 25.53%      
  KRY -32.88%      
  DELL -9.64%      
  WFC -17.58%      

Data source:
Research assistance: Ivy Cui

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Janice Revell of Money Magazine makes a good case that inflation is more of a threat to your retirement than a recession.

Bob Klosterman asks if you are undermining your financial independence by overly risk-averse.

James Hamilton writes scholarly about predicting recession and stagflation.

Talking about inflation, we can’t ignore China’s role. Ebn Esterhuizen has an essay on that.


Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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