Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay is a classic book that was published in 1841 on the foibles and follies of human beings especially in crowds. The book first appeared in a three-volume set, covering national delusions, peculiar follies, and philosophical delusions. Through the years, MacKay updated the book to include such discussions of investment manias and economic bubbles. It is a study in mass human psychology that is well worth reading here and now. Human beings and their interaction in crowds, be they in a physical riot or an investment scheme always follows certain patterns that can be identified ahead of time if one has the proper historical perspective.
Two weeks ago, we wrote about using psychology as an investment tool, and an indicator provided by CNN Business which is available free online (please refer back to the blog post for Thursday, October 28, 2021 – Sentiment and Psychology). Recently, the CNN Fear/Greed indicator had an “extreme greed indication” of 86 on this past Monday the 8th after several days closes in the low 80s. The scale of the indicator runs from 0 to 100. As we stated two weeks ago, one should observe how the indicator acts before trading on it. But this is nose bleed territory and it has been elevated for the past week or so.

Another indicator of investor sentiment is margin usage which recently hit all-time high levels. That in of itself is not bearish, but it is of concern. One should keep appraised of this statistic. It tends to be coincident with whatever the equity markets are doing, expanding in up markets, and contracting in down markets. One can chart this statistic much like a tradeable instrument, with trendlines, etc. Traders can tell a lot about whether people are being forced out of margin trades (capitulation) by watching for steep declines in margin usage.

Another gauge of sentiment can be found in the nature of advertising, especially investment-related advertising. These days people are glued to their handheld devices, so it tends to be much more subtle than in years past. During the dot-com bubble, there were funny commercials that featured sock puppets for pet food delivery services, where large uneconomic cash outlays were made for Super Bowl advertising spots. Rather ridiculous in hindsight, but that was the “attitude” of many internet companies of that time. To date this year, we have not seen such a euphoric advertising background as back then. But we are on the alert to see if once again the psychology of excessive optimism appears in commercials.

For now, markets are at all-time highs, and most have profits in their positions. Sentiment argues for a pause in the least. With the backdrop of a less accommodative fed, and a potential effort by Congress to bring another multi-trillion-dollar spending package (with tax hikes) before the end of the year might start to weigh on psychology.

Keep an eye on the trendlines coming off the most recent lows, and an eye on the CNN Fear/Greed indicator as a sustained break below the 70 level that sticks might portend lower equity prices.
Stay safe and trade well.


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