IRRATIONAL EXUBERANCE? WHAT THE HECK. IF YOU ARE IRRATIONAL, YOU MIGHT AT LEAST BE EXUBERANT ABOUT IT.

GREED AND FEAR. FEAR AND GREED. WHICH IS IT?

April 24th’s newsletter from John Mauldin, “Outside the Box”[i], features James Montier, Director of Global Strategy at Dresdner Kleinwort Watterstein, a London and Frankfurt based investment bank. The title of the Mr. Montier’s article is “The Dash to Trash”.

IRRATIONAL EXUBERANCE DID NOT END WITH GREENSPAN’S RESIGNATION.

Former Federal Reserve Board Chairman Allan Greenspan made frequent reference to the irrational exuberance of the later 1990s equity markets. He warned that investors when risk premiums are low (investors overpay for risky assets), declines in value follow. Simple lesson, no? Apparently not.

Lesson to how Mr. Montier describes the almost “liquid” (or liquidity?) induced mettle of equity investors:

Investors seem to be displaying signs of pure fearlessness. Perhaps they see themselves as high-wire walkers, bravely showing their skill to the breath-holding crowd. To us they look more like Wile E. Coyote, running in thin air before looking down and realizing they have nothing to support them, and succumbing to the inevitable gravity check[ii].

DON’T LOOK DOWN. OR LET BUGS BUNNY HAND YOU AN ANVIL.

Mr. Montier uses some of his favorite indicia to describe this overextended and under-hedged market. First, relying on his “DrKW Fear and Greed Index”, he notes that the “greed” levels are at their highest since January 2000. He next tells us that NASDAQ short interest, as measured by the QQQQ (NASDAQ Index, often called “cubes”) is only 1.5 days.

On the overextended long side, he notes that the NASDQQ trades at 40 times trailing P/E ratios and that the more volatile small cap stocks are out legging quality larger cap holdings.

BUY VALUE. OR FLY HIGH AND BAIL?

Mr. Montier’s advice, as a value-oriented advisor, is to move to value investments and pick up some good bargains. Good advice, if you are a value analyst. But if you are momentum-based relative strength investor such as the Author, what do you do?

First, you let the winners run, but you tighten up the stops. Second, be careful introducing new money into this hot market. We don’t know where the top is, but our indicators will start telling us when the market starts slipping.

Finally, work up a protective strategy when this Cyclical Bull Market falls back upon its Secular Bear Market roots. More on this latter. But don’t jump off early. We should wait for the indicators to tell us when.

DON’T LEAVE THE JUNK IN THE TRUNK. IT WILL GET OVERHEATED AND SPOIL IN THE DESERT OF THE REAL!


[i] http://investorsinsight.com/

[ii] http://investorsinsight.com/otb.aspx