Fear, Greed & the Average Investor

Understanding the role of fear and greed in the stock market is crucial for investors seeking to make good investment decisions. While these emotions can create opportunities, they can also lead to costly mistakes if not properly managed.

Both fear and greed lead to extreme market conditions, which, in turn, has historically caused investors to make irrational decisions. When fear dominates, investors tend to sell their holdings rapidly, driving prices further down and often creating undervalued assets. Conversely, when greed takes over, investors often engage in speculative buying, pushing prices to unsustainable levels. Think for a moment about the wide and rapid swings in company and market valuations we have seen recently. NVIDIA (NVDA) has lost roughly $1 trillion of market capitalization since it’s peak in early January. Does the real value of any business shift so rapidly? That is highly unlikely. More likely, these intense emotions push market valuations much higher or much lower than the real  fundamental value.

The Fear and Greed Index, developed by CNN Money, is a tool used to measure market sentiment on a scale from 0 (extreme fear) to 100 (extreme greed). The index, which stood at 21 after Friday’s close, incorporates seven key indicators to assess market sentiment.

      • Stock Price Momentum: Compares the S&P 500 to its 125-day moving average.
      • Stock Price Strength: Analyzes the number of stocks hitting 52-week highs and lows on the NYSE.
      • Stock Price Breadth: Measures the volume of shares traded in rising vs. declining stocks.
      • Put/Call Ratio: Evaluates options trading patterns.
      • Junk Bond Demand: Assesses investors’ appetite for higher-risk investments.
      • Market Volatility: Utilizes the VIX index to gauge market fear.
      • Safe Haven Demand: Compares the returns of stocks vs. bonds.

 

The fear side of the equation is generally easier to spot. The COVID-19 pandemic in March 2020 demonstrated how fear can rapidly take hold of the market. As the virus spread globally, the Fear and Greed Index plummeted and hit a level of 2 on March 12,2020, one of its lowest levels ever recorded, reflecting widespread panic and uncertainty. The fear tends to make us blind to opportunity.

The greed side of the equation is harder to recognize. The tech bubble of the late 1990’s is a perfect example. Although the index did not exist then, it certainly would have registered very high on the greed scale. Ultimately the bubble broke, as they always do, but the greed persisted for a very long time before the bubble finally burst. At the time, the tech bubble appeared so logical. The Internet was going to be a game changer. Ironically, it was a game changer, but the change wasn’t how it was envisioned at the time. The greed tends to make us blind to risk.

Warren Buffett’s famous advice, “Be fearful when others are greedy, and greedy when others are fearful,” encapsulates the contrarian approach to investing and suggests that periods of extreme fear present buying opportunities, while periods of extreme greed signal a good time to be cautious.

The index is now signaling fear, but that is a very recent event and fear can persist just as greed can persist. In our view, the index implies that a short-term market bounce is in order, which we can easily argue occurred on Friday. Can it be sustained? We would guess there will be another leg down, because after a very long run up in the stock market (greed), positive technical trends generally remain in place. The fear isn’t ‘real’ until those trends are broken. Hopefully, we are close to bargain hunting time.

Have no fear!

 

What We’re Reading

  

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

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By: Adam