Thursday, September 9, 2010

Measuring Risk Appetite (3)

In a previous post I commented on the “Doomsday Trades” such as the 10-yr T-Note (TLT) or the Japanese YEN. Investors who embrace these “safe” assets are the perma-bears or lunatic fringe groups who basically couldn’t see a bull market in any asset class – even if it bit them on the ass. Here is a quote from the brilliant 1978 publication Cycles, What They Are, What They Mean, How to Profit by Them - Dick A. Stoken

When risk takers become risk averters, "Consumers now postpone their purchases, while business executives either terminate their operations, or reduce debt, fire workers, and discontinue unprofitable ventures." and, "As the demand for money lessens, long-term interest rates fall below the natural rate (adjusted for past inflation). This fall in the cost of capital to below the natural rate is now an error of pessimism." Stoken is suggesting that when too many become risk averters and stampede into safe places they are usually wrong.

In our iShares Barclays 20+ Yr Treasury Bond chart I have used two studies that best display sheep-like bullish and bearish stampedes in and out of an asset class – in this case the U.S. long bonds. The Percent K is a very slow stochastic and the Percent R is a measure of price deviation from the longer term average. Note the over bought and over sold ranges – always good places to move against the investment sheep. Our studies currently display too many sheep crowding into the error of pessimism space.

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