A majority of investors, including those on Wall Street, are suffering from recency bias. As human beings, most of us suffer from such a bias. What is it? It’s the presumption that whatever has been happening recently will continue to happen.
For a decade, the stock market has, more or less, gone straight up.
To balance recency bias, prudent investors ought to look at history to gain objectivity. Let’s explore the issue with the help of a 25-year chart.
Please click here for an annotated 25-year chart of S&P 500 ETF SPY, +0.09%, which tracks the benchmark S&P 500 Index SPX, +0.07%. Similar conclusions can be drawn from the chart of the Dow Jones Industrial Average DJIA, +0.06%.
Note the following:
• There is no close historical parallel to the current stock market.
• Stock markets all over the world have been rigged by central banks, which have kept interest rates low for years.
• There is one striking aspect in which the present-day stock market is similar to that of 1999.
• As the chart shows, in 1999, the stock market was primarily controlled by the momo (momentum) crowd. And 20 years later, in 2019, the stock market is primarily controlled by the momo crowd again.
• Nobody wants to talk about the momo crowd because it is not in the interest of the establishment. The stock market is going up not because of higher earnings, not because the economy is getting significantly better and not because valuations are low. Buying in the stock market is occurring simply because it is going up. If analysts were to admit this simple fact, there would not be much need for their seemingly sophisticated analysis.
• The most instructive point from the chart is a big downturn in the market, starting in the year 2000 for three years.
• The chart shows the Arora sell signal and calls to go 100% in cash, buy inverse ETFs and short-sell for those who could in 2007 prior to the 2008 crash. In 2007 it was not the momo crowd in the stock market but the crowd in housing-related securities and speculators in housing. The present period is not like 2007.
• In 2008, most portfolios lost half of their value.
• The chart shows the Arora signal to buy aggressively in 2009, which turned out to be the bottom.
• Markets are difficult because when it is all said and done, they depend on mass human psychology, which is difficult to predict. There is no guarantee that we will be able to successfully predict the next downturn in advance. For this reason, it is important to have some protective strategies for long-term portfolios in place now.
• The chart shows RSI (relative strength index) divergence. In plain English, it means that as the stock market has risen, internal momentum is not keeping pace. This is a reason for caution.
• The chart shows that volume is low. This indicates a lack of conviction in the rally. This is another reason for caution.
• Right now, investors keep on buying popular stocks such as Apple AAPL, +0.28%, Amazon AMZN, +0.96%, Facebook FB, -0.43% and Google GOOG, -0.47% GOOGL, -0.50% at a rapid pace. Strong buying by the momo crowd in these stocks suggests that the risk in these stocks is drastically under appreciated.
• There is strong buying in semiconductor stocks such as AMD AMD, +0.31%, Nvidia NVDA, +0.86%, Intel INTC, -0.19% and Micron Technology MU, +0.43%. Again, the momo crowd is under appreciating the risks.
• For shorter-term analysis, please read “Believe in a Santa Claus rally if you want, but first look at this chart.”
• The biggest thing going for the stock market in the short term is that Trump pays a lot of attention to the market. He’s likely to do anything he can to keep it levitated going into the election. Will he succeed? Please read “Trump perfectly orchestrates the stock market’s rise whenever momentum wanes.”
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What does it all mean?
There is an old saying in technical analysis: “The trend is your friend.” Right now, the trend is up. It is important to stay invested to take advantage of the bull market. However, it is more important to not be complacent, have some protections in place and the mind set to overcome recency bias to change quickly if market conditions change.
Consider getting ahead of the curve by learning how adaptive models that have a proven track record in both bull and bear markets.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.