Recently, I’ve felt as if I’m stuck in a time loop, like the character in the movie Groundhog Day. Phil Connors, a weatherman, played brilliantly by Bill Murray, wakes up each day to the same scenario on Groundhog Day. He’s stuck in a time loop.
For me, that loop consists of long positions that go down and short positions that go up.
It’s been the same thing each day, often with no news. There are small-cap stocks that have made 25% pullbacks on no news. I look every day to make sure I’m on top of things… no news… nothing… just prices going lower.
I’m seldom emotional about stocks. But it’s getting a bit trying. I think the best thing to do is find a way to break the loop and use any positivity to trade better.
Unfavorable Sentiments for the Market
One reason there’s not much going on is that overall sentiment of the market is not favorable. Small caps need a breather. And they’ve gotten it. In some instances, there’s been too much of a breather. But it’s worth stating that there’s been some huge moves in small cap. While I’m tempted to double up, now is not the time.
The second reason is that, while the overall market sentiment isn’t favorable, we’re also entering the beginning of earnings season. It’s make-or-break time for many stocks. The best course of action is to digest the earnings reports as they come in.
However, the sentiment around earnings is a bit negative. There are some mixed signals: too much overall bullishness coupled with concerns about earnings reports coming up.
Last year, companies enjoyed the tailwind of large tax cuts. Stock buybacks have also driven returns. This could very much be a “show me” quarter for a lot of stocks. Companies that deliver quality results with bright prospects will be off to the races. There will be a big sigh of relief and even bigger buying. Any whiffs will be met with punishment.
Let’s take a closer look at that sentiment analysis. Below is a chart, courtesy of Sentimentrader.com, that shows the spread between “smart money” and “dumb money.”
The Difference Between “Smart Money” and “Dumb Money”
An example of “smart money” is commercial hedgers in commodity markets. They represent true insiders in a market.
On the other hand, “dumb money” includes folks who are normally very wrong, like Joe Sixpack. He buys at extreme highs and sells at extreme lows. Emotions get in the way of him making any consistent gains in the market.
As you can see, we’re in the red zone. “Dumb money” is way too bullish.
That doesn’t mean returns are negative. In fact, returns going forward from sentiment levels like these average about 4% annualized. That’s below average, but it’s not disastrous. However, when the indicator is above the green zone, the returns are 17% annualized.
That’s the difference between floating in a canoe and sipping champagne on a yacht.
There’s no guessing here, either. The data is what the data is. So, I’m not going to put good money after bad right before earnings season for the sake of a trade. I’m going to continue to monitor any current positions. I’m going to scour the news.
I’m going to look at the financials again and draft a game plan for earnings season and what to do as it unfolds.