A Volatile Period
Peter Boockvar inventoried sentiment shifts in his April 17 Substack post at the Boock Report, published before the April 18–19 Hormuz chaos news. We excerpt below:
With this incredible and rapid two-week rally, the CNN Fear/Greed index has risen to 63, in the middle of the ‘Greed’ section and well up from the late March bottom of 10 when it was in ‘extreme fear.’ The Daily Sentiment Index fell to just 12 at the end of March and was at 78 yesterday according to my friend Helene Meisler. The SPX stands at 76. The NAAIM Exposure Index closed yesterday at 79 vs 60 in March. Investors Intelligence (covering sentiment last Friday so I’m sure the Bull/Bear spread has widened much further) saw Bulls rise to 39.6 from 33.3 and Bears dropped to 22 from 27.8 and vs 31.5 in the week before. Last weekend saw the Citi Panic/Euphoria index back in Euphoria land at .43. The outlier to this bullish shift in line with the market rally is the very volatile and fickle AAII retail survey, my least favorite, where Bulls fell 4 pts to 31.7 vs Bears at 42.8 that was little changed.
Bottom line, record highs certainly brought back the Bulls, and they came stampeded in but there is nothing extreme here yet. The breadth though has been lacking. In January, 68% of NYSE stocks were trading above its 200-day moving average. Yesterday at index record highs that figure stood at 57%.
(“Sentiment/Data center delays/Banks, PC/Most hated sector/Manpower on labor, Alcoa on supply” | Boock Report, https://peterboockvar.substack.com/p/sentimentdata-center-delaysbanks)
The Role of Wealth Concentration
As we examine what is happening with the stock market, it’s important to keep in mind that wealth in the US is increasingly concentrated, and that is a contributing factor to increased volatility. Why? Investing people are moving around greater sums of money per capita. Here’s the summary on this issue from the April 20th edition of TLR on the Economy:
Consumer sentiment, something dark is going on
The share of overall wealth fell by seven points among those in the 50% to 90% bracket of the distribution, the “next 40%,” between 1989 and 2025, and the share of the top 1% rose by nine points. The wealth of the next forty more than doubled over that period, while the share of the top 0.1% quintupled.
When fewer people put more money in motion, the per capita stock market vol increases with sentiment shifts. In statistics we call that kurtosis. In other words, mean reversion becomes an investor’s trap because the extremes in the bell curve are more intense. The outcome distribution curve changes while the mean remains the same. Hence the risk is greater in the “tails.” Below is a graphic to illustrate. (Note to certain quant or “math geek” readers: I’m temporarily ignoring heteroscedasticity and leptokurtosis to attempt to keep this commentary less complicated for many readers. As you will see at the end of this missive, I do not ignore them in my analysis.)
How Markets Have Responded to Sentiment Shifts
We will get more technical at the end of this missive (before drawing some conclusions in nontechnical terms), but for now let’s turn from this technical math stuff and look at a few ETFs. We want to observe how markets responded to the roller coaster sentiment shifts.
We will start our charts in February, so we capture the market volatility before and since the Iran war started. We will end the chart date May 1 after the closing prices are recorded. We can see how the powerful market rally extended and what happened after the chaotic weekend of April 18–19, after President Trump announced that the Strait of Hormuz was open and Iran had agreed to the US demand for cessation of its nuclear program, and then the announced deal fell apart in a day.
This selloff, subsequent rally, and market movement after the April 18–19 weekend chaos were not confined to large caps. We’ve selected three charts to tell that story.
Here’s SPY, the classic ETF for the S&P 500 index.
And next is MDY, the S&P mid-cap 400.
And, lastly, IJR, the S&P small-cap 600.
We use these three ETFs because we can observe the US stock market with some consistent factors applied by an unbiased source. S&P has criteria for a stock’s inclusion in or expulsion from an index. (For details, see S&P U.S. Indices Methodology at www.spglobal.com.) This is why we use the S&P 600 Small Cap Index instead of the Russell 2000 Index for small caps. The Russell 2000 criteria are quite different than the S&P factors. We want to compare apples with apples and not with oranges.
Using this approach helps us compare the more internationally exposed large caps with the more domestically exposed small and mid caps. There are pros and cons to cap-weighted indices. That said, using the S&P gives investors the means of tracking the better-performing companies that S&P determines to include in each index.
US stock market volatility during the Hormuz Hope Rally has been dramatic. The same is true for some other national markets. Here are two of them.
We look at Japan using EWJ. Remember, there are some currency exchange-rate changes incorporated into this pricing. Last week, Japan intervened in the currency exchange markets involving its currency.
And we will look at South Korea using EWY.
Both countries are large importers of oil. And both countries are allies of the US. Note that South Korea has a large and growing defense establishment component as well as a heavy tech component because Samsung and SK Hynix are included in the ETF basket. Note that Japan just announced a large defense contractual agreement with Australia. The new government of Japan has changed policy and now allows Japan to export weaponry. Japan has historically been a master of “improvement technology.” I expect both countries to surge in applications and exports for warfare and defense.
An Investor’s Dilemma in Wartime
The issue during a war scenario is simple. You and I, as investors, can never be current on the state of the war. The most important information is not made public by the antagonists unless there is a security leak or breach. The US, Iran, and others are using publicly released information as a tool of war. Some war outcomes may be revealed through independent research services. I have cited many of those in various Kotok Reports. But the headlines you read and images that you see are after-the-fact reports. If they are sourced with an antagonist, they are usually released with a propaganda plan that you do not see.
So, as I see it, the investor must make a choice. If you think the US will lose this war and be permanently damaged, there is an option. If you believe that, get out of the markets and wait until all the kinetic warfare is over. Or do something other than stock market investing.
How I Tackle This Dilemma
But if you think the US will survive, and the world’s largest economy will continue, then stay invested in US stocks and bonds using a consistent and time-proven strategy. That is what I am doing by using a method with years of history that I am comfortable with.
For US markets, I use a basic 60%-stocks 40%-bonds, ETF-based strategy that I developed and implemented in Cumberland many years ago. It has a specific rebalancing methodology. It does not react to headline news flow even during a war. That means you don’t panic on the war outbreak news, and you don’t chase a market rebound after a fear-led selloff. There is no FOMO, “fear of missing out.” There is no TACO “Trump always chickens out.” There is no guessing about what will happen if you don’t chase the Hormuz Hope Rally. Or if you do.
Disclosure: I am now a paying client of Cumberland, and Matt McAleer’s team implements this strategy for me and for other Cumberland clients who use it. My role at Cumberland is now that of strategic advisor to the board of directors. I am not an employee. I am not the CIO or a portfolio manager. I am an independent contractor who consults for Cumberland’s board.
For the international markets, I use a different methodology that Matt McAleer implements with ETFs. You can obtain information from him on both strategies via the Cumberland website, www.cumber.com.
Now Back to the Technical Stuff
For those who are inclined to trade this high-volatility, headline-driven market, there are things you can do. First go back and look again at kurtosis and the three bell-shaped curves. In markets like the Hormuz Hope Rally market, the mean is the same, but the tails have shifted.
But the Hormuz Hope rally does not have a normal distribution like the bell-shaped curves; it’s bimodal. Investors need to understand that the present Hormuz Hope Rally stock market environment produces curves that are skewed, and some are bimodal. Just conceptualize the ceasefire as an “on again, off again” news flow, with a graphical depiction. It would be bimodal. And asymmetrical.
For a further explanation, please look at the following paper by Kahadawala Cooray:
“Exponentiated Sinh Cauchy Distribution with Applications”| ResearchGate, https://www.researchgate.net/publication/263345601_Exponentiated_Sinh_Cauchy_Distribution_with_Applications
Here’s the key excerpt, from the abstract:
The asymmetry parameter changes the symmetry of the distribution by producing both positively and negatively skewed densities having coefficient of skewness values ranging from negative infinity to positive infinity. Bimodality, skewness, and kurtosis properties of this regular distribution are presented. In addition, relations to some well-known distributions are examined in terms of skewness and kurtosis by constructing aliases of the proposed distribution on the symmetry and asymmetry parameter plane.
When you read the article, you will come to the six-chart description of modality (Figure 1). The lower right-hand chart in that figure, excerpted below for educational purposes, is the key item to help investors understand what is happening with the Hormuz Hope Rally.
Sinh Cauchy Distribution with Applications”| ResearchGate, https://www.researchgate.net/publication/263345601_Exponentiated_Sinh_Cauchy_Distribution_with_Applications
The market responses are best understood as bimodal, with the right tail larger (more data points) than the left tail. Note the mean is in the valley between the two modes, which is why mean reversion is a trap for an investor. The right mode is larger because the upward bias of stock prices is dominant over the downward correction bias. There are two reasons for this phenomenon. (1) Historically, markets spend more time rising than falling. Markets tend to rise 75% of the time, in part, due to an inflation bias in the underlying currency, whether US dollar or other currencies. (2) The upside potential of stock markets is open-ended over time, but the downside is limited and cannot go below zero. So, the combined biases of inflation and larger upside make the right mode larger than the left mode. The curve on the positive side rises because the scatter plot of data points from which the curves are derived has a larger number of positive numbers.
Note how “the Greeks” can be used to capture these changes, as we demonstrate below with the Nomura example. And since those changes are rapid, we must use indicators that are high-frequency and can quickly capture changes in market sentiment.
Peter Boockvar listed some of the mainstream indicators. And the impact from the sentiment shifts is measurable with the Greeks like delta, gamma, vega, or theta, if you do the work to derive those indicators. There are other measures like MOVE and SKEW that can help. But to trade them requires resources and skills and close attention paid to them.
Here’s an excerpted chart from the wonderful research provided by Charlie McElligott of Nomura Securities Intl.:
Kotok personal (and technical) note: I like gamma best for securities and financial market reactions. Gamma is the change in the (delta) rate of change. It captures acceleration and deceleration quickly. As you can see from the above chart, the gamma calculation on this delta is so high as to set all-time records of extremes. In math terms, with a delta in the 99.8 percentile, gamma for the above vol would nearly be a singularity (an unusual and nearly one-time event).
My Conclusions
So, my bottom line is simple. Trading stocks in a wartime scenario is trying to do something without complete information during extreme and exceptional circumstances. You may make a profit and think you are very smart, but (mathematically) you really won’t know why you succeeded. The same is true if you trade and have a loss. Or if you break even.
Reacting to headlines is a risky venture and can often hurt more than help the investor. So, I don’t do it. If I tried to do it, it would be an intense and consuming task that would require total concentration and no distractions. At age 83, I have decided to pass.
In my opinion, it’s hard enough to invest wisely in peacetime.
I know some readers will disagree. I’m most curious to hear from quants and math geeks and see if some agree or, most importantly, some disagree with me, and why they disagree.
It is that disagreement that helps me learn. And, by the way, it also helps to make for an active stock market.
Good luck.
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