Be Greedy When Others Are Fearful

By TradeSmith Research Team

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I love Warren Buffett’s mantra to be greedy when others are fearful and fearful when others are greedy, but the Oracle of Omaha is missing an important question with that advice: What do you do when people are neutral?

It’s not as easy to answer.

If people are fearful, it can mean that stocks are oversold and it’s a good time to buy quality companies at a discount compared to where they could be trading in the long term.

We just saw this play out, thanks to TradeSmith’s Market Health tool and its Fear & Greed feature. The S&P 500 closed on Sept. 29, 2022, at 3,640.47, with the sentiment of Extreme Fear.

By the time the first Extreme Greed signal hit on Jan. 31, 2023, the S&P 500 closed at 4,076.60, representing an 11.98% rally from September’s Extreme Fear signal.

You can also see in the image above that from January to February, sentiment bounced around between Greed and Extreme Greed (indicated by the light blue and dark blue lines).

The tool obviously didn’t predict that a banking crisis was ahead, but it indicated that the markets may have been overbought at that point and due for a cooldown anyway.

Then, banking collapses dominated the headlines, and Fear sentiment took over.

There was a slight shift to Greed after that, but sentiment is now Neutral.

So, if you’re supposed to be greedy when others are fearful and fearful when others are greedy, what do you do when there isn’t a firm direction?

What you can do is look at the data.

Stuck in Neutral

Being Neutral makes sense, as folks are likely still digesting the Federal Reserve’s rate hike last week… and there was a lot to digest.

If the Fed didn’t hike rates, it would have been a sign that the Fed didn’t believe the economy was strong enough to handle it. If the Fed hiked rates higher than expected, it could have put even more pressure on the cracks already spiderwebbing around the banking sector.

The Fed matched expectations with its quarter-point hike, but there is still obvious concern about other banks collapsing. It will also be worrying if inflation comes in much higher than expected in the next Consumer Price Index release.

That may keep people Neutral for the time being.

But what you should be focusing in on next is the fact that the Fed signaled it is nearing the end of its rate hikes.

Here’s what I told the members of Dividends on Demand yesterday. (You must be logged in to access; if you’re not a Dividends on Demand member and would like to learn more, you can click here.)

The Fed knows full well that the banking system is the lifeblood of commerce in America. Regional banks in particular account for the majority of small business and real estate lending nationwide. Make no mistake, the Fed will do whatever it takes to backstop the financial system.

On that note, stocks and bonds rebounded across the board last week, with the S&P 500 Index up 1.4%. The yield on 10-year Treasuries fell to 3.38% as bonds rallied too. That’s down considerably from the recent high in yields of more than 4% in early March. The Fed is clearly coming to the end of the rate hike cycle, and it cannot happen too soon for stocks.

As you can see in the chart below, stocks tend to perform quite well in the 12 months after the end of rate tightening cycles in the past.

The S&P 500 has posted gains after five of the past six cycles and has gone up an average of 17.6%.

It’s an oversimplification to say that there are a lot of forces at play right now, and the overall markets may be volatile or trade sideways in the short term.

But if history is going to repeat itself after this tightening cycle, it may be well worth it to start thinking about being greedy when others are neutral.