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Is the Market Too Complacent?

Is the Market Too Complacent?
Ron DeLegge
October 21, 2011

After getting spanked almost 9 percent over the past few months, stock prices have snapped back. The Schwab Total U.S. Broad Market ETF (NYSEArca: SCHB), which tracks the total U.S. stock market, has gained 6.27 percent over the past month. Office party anyone?

Similarly, stocks in developed global economies have risen. The iShares MSCI EAFE Index Fund (NYSEArca: EFA) which follows stocks from countries like Japan, Germany and the United Kingdom gained 8 percent over the past month. Even European stocks (NYSEArca: VGK) have jumped around 11 percent.

Despite the still fragile nature of the global economy, the European debt situation, and the worst recession since the Great Depression, have stocks come too far too fast? Are investors too complacent?

Falling Fear not Fear of Falling
One way to answer these questions is by analyzing the VIX index (Chicago Options: ^VIX), an indicator of marketplace fear that attempts to measure stock market volatility. By using a weighted blend of various S&P index options, the VIX attempts to estimate the implied volatility for the S&P 500 (NYSEArca: SPY) over the next 30 days.

With the VIX trading around 31, fear by this popular measure has fallen considerably. Put another way, as stocks have risen, volatility and fear have declined. In many ways, risk appetite, especially for risky assets like emerging market bonds (NYSEArca: PCY) and high yield debt (NYSEArca: JNK) has increased. This has been fueled, in part, by today’s low interest rates and the Federal Reserve’s monetary tinkering.

Another factor is investor’s behavior, which tends to be self-destructive rather than self-preserving.

How do investors choose what to buy or sell? Investment decisions are driven not just by fear and greed but memory loss. In some minds, the stock market thrashing of three years ago are ancient history. Confidence that stocks can repeat their 2009-10 success has become the general consensus, especially among financial experts. As a group, Wall Street’s strategists still foresee an 11 percent gain for the S&P 500 index in 2011.  

Avoid the Herd Mentality
In the long-run, the crowd and its herd mentality is usually wrong and so is expert driven analysis based upon conventional wisdom. And while betting against them is never easy, it’s often profitable. This is the strategy that ETFguide's Ready-to-Go ETF Portfolios have taken.  

Since the beginning of the year, our Generation Growth ETF Portfolio is ahead by 1.96 percent while our Sector Savvy ETF Portfolio is up by 9.13 percent, compared to a 1.71 percent decline for the S&P 500. What does it prove? It shows that good results don't happen by accident, but rather, through the careful allocation of investments. It also proves that good results can be achieved even during the worst of times.

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