As disciplined investors having been active in the financial markets for more than two decades, there is an overwhelming amount of evidence that suggests we should celebrate current markets and lower stock prices for the best quality companies understanding that the irrational behavior of market participants during periods of market distress and uncertainty are almost a necessity for creating market inefficiencies and generating buying opportunities/opportune entry points. This blog post touches a little more on that.
It is important to understand that when you buy stocks drastically affects long term returns and for the best quality companies all else being equal, as the price goes down, the risk goes down while the margin of safety goes up. Rather than letting the media conjure up fear and panic in your investment decisions, it is paramount to shut out the noise, be emotionally disciplined, and base your investment decisions on rules and well specified criteria.
Fundamentally speaking, while the S&P 500 with its most recent decline has become less overvalued from its peak in the middle of February, it is still very overvalued based on a multitude of metrics.
While the market is a weighing machine over the long term, in the short term it is a poor timing mechanism as market prices are buoyed more by the popularity of issues and pervasive sentiment governing markets. And with the VIX around 21.5 and the PUT/CALL Ratio around 0.57, market uncertainty and pessimism are still far from terminal extreme values.
Back in December 2024 we wrote a blog post “Is the S&P 500 Extremely Overvalued Now: A Minsky Moment?’’ in which we referenced “when we apply our proprietary technical analysis to the S&P 500 on a medium/long term basis, the market price appears to be in an uptrend that is mildly strengthening yet has not triggered a terminal extreme, absent institutional pools of resistance with our 6100-price target still intact…medium term institutional pools of support appear around 5721 and 5334. Now if market calamity strikes, we see a probability the market could test strong institutional pools of support around 4800 and 3500.”
On the date of this writing, the S&P 500 on a medium/long term basis appears to be undergoing a retracement in price yet has not reached a terminal extreme. The market price has broken institutional pools of support around 5721, with the next level of institutional pools of support around 5334.
Now if the market price breaks below 5334, we have identified strong institutional pools of support around 4800 and 3500.
Our core principles are scientifically constructed on the premise of mean reversion akin to a pendulum that swings from the zero-scale line at equilibrium between two opposing extremes. Our quantitative approach to the markets precisely measures these opposing terminal extremes based on unsustainable pessimism and unsustainable optimism when the strength of the trend is becoming directionally unsustainable and a reversion to the mean appears more probable. These terminal extremes are well specified zones where the reward appears asymmetrically greater than the risk and vice versa.
The Practical Contrarian is a boutique financial consulting firm that helps guide family offices, hedge funds and institutional investors around the world based on a data driven approach using well specified investment criteria to remove the human factor and guesswork from the investment decision-making process.
If you are an institutional investor that needs guidance on constructing time tested, customized, data-driven approaches to investing in the S&P 500 or in securities of various asset classes, let’s connect.