Warren Buffet remains one of the most famous investors out there, so it’s no coincidence that his sayings are equally famous. One of my favourite Warren Buffett sayings has to do with two key emotions in the investment world: “Two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. … We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Genius, Albert Einstein, said that compound interest is the eighth wonder of the world. “He who understands it, earns it … he who doesn’t … pays it.” Now, I would never dare to disagree with a man of his calibre, but I would like to add that if compound interest is the eighth wonder of the world, then the ‘herd-effect’ has to be the ninth. The herd-effect is without a doubt one of the strongest forces out there, not only when it comes to consumer goods, but even stronger in the investment realm.
And this is exactly where the herd-effect fits in so well with Buffett’s advice on being greedy when others are fearful. But can we measure this effect and express it as a figure? With the help of historical data (which is no guarantee for future performance), I was able to find part of the answer in the Fear & Greed Index, made famous by CNN Money.
I’ve been following this index for quite some time and I have found that along with the fact that many short-term indicators use this index, it gives us a good indication of the emotional state of US markets. I did some investigating on the mythology of this index and decided to apply/build it around the South African investment market as far as I possibly could. The results were quite surprising.
In the South African version of the Fear & Greed Index, I used five indicators:
Here I simply looked at the South African Volatility Index (SAVI) and analysed how high (fear) or low (greed) it was trading above or below its 50-day moving average.
Running towards safety
This is one of the reasons why share prices go down when bond prices go up – the fact that so many investors choose to switch to “safer” investment options in times of fear. I used the FTSE/JSE All Share Index’s 20-day average returns and deducted it from the 20-day moving average of the SA All Bond Index (ALBI). When share prices start to drop and ALBI prices start to rise, it can indicate fear.
Share price strength
Having a look at how many companies make it to the JSE 52-week highs vs. how many make it to the 52-week lows also gives us a good indication of the levels of fear or greed that exists in the market. To place this in context: there were seven more shares per day on the JSE 52-week highs compared to the 52-week lows over the last 12 months. This is a clear indication of the recovery we have experienced since 2020’s lower levels.
The breath of the JSE
By using the McClellan Oscillator, we can build an index by subtracting the daily total amount of shares that showed a net share price increase from the total amount of shares that showed a net decrease. If this net result is positive, the graph will move upwards and this will give us an indication of greed. On the flipside, if the net result is negative, the graph will move downwards and give us an indication of fear.
Sometimes, just by looking at an ordinary moving average, we can spot a trend on the JSE. I took the JSE’s price levels relative to its 125-day moving average. If it trades above its 125-day moving average, greed is on the rise, while if it moves below this moving average, fear is on the rise.
By combining these five indicators (in equal parts) and indexing them (0-100), we can create a “barometer” which can measure greed and fear. Levels between 0 and 20 indicate extreme fear levels, while levels between 80 and 100 indicate levels of extreme greed.
At the time of writing (15 October 2021), the Index once again moved away from extreme fear levels closer to normal levels. I’m using the words “once again”, simply because the index has dropped to 20 or lower (extreme fear) three times since the Covid-19 pandemic started. The first time was in March 2020, of course, during the great correction, and we all know how well the stock market recovered afterwards. The second time was at the end of October 2020, and the JSE bounced back with a 10% increase in the following month. The third time was at the middle of last month, and the JSE is already trading 10% higher compared to levels seen on 20 September 2021. Put into context, Warren Buffett was spot on when he said it’s wise to be greedy when others re fearful.
I would like to conclude by making it clear that my message is not to try and use the Index to trade speculatively over the short term, but rather to be very cautious when it comes to following the herd, irrespective of whether it’s related to shares, crypto assets or any other type of investment for that matter.
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