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- With Trump’s trade wars taking a turn for the worse, investors haven’t been this worried in years. But one Wall Street strategist says that fear is a sign stocks are poised to climb.
- Jim Paulsen of Leuthold Group says that since 1990, periods where investors were very defensively positioned, as they are now, were followed by much bigger gains than other periods.
- He writes that the more defensive the market is, the better it tends to do over the next six months.
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A little fear can be a healthy thing.
Investors have endured a rocky ride since US-China trade talks fell apart, and while stocks are on the verge of new highs as traders hope interest rate cuts will keep the economy going, there are signs Wall Street is more nervous than it’s been in years.
Those investors are concerned stocks will struggle and the economy will weaken if the trade situation gets worse. But Jim Paulsen, chief investment strategist for the Leuthold Group, thinks that fear is a very good sign. He says that over the past three decades, moments like this one have resulted in the stock market’s very best performance.
"The degree of exhibited defensiveness among investors has been a good indicator of future stock market potential," he wrote in a note to clients. "Defense is suggesting investors should be on offense!"
Paulsen illustrates his reason for optimism with this chart. The "defensiveness indicator" measures how well traditionally defensive stocks like utilities and telecom are faring compared to their cyclical counterparts, and also compares the price of gold to other commodities.
Gold is at its highest price in almost six years, so it’s not surprising that the defensiveness indicator is returning an elevated reading. Paulsen breaks the indicator’s results down into five quintiles: On the left side of this chart are the highest 20% of readings for the indicator, followed by the next 20%, with the lowest 20% on the far right.
The chart shows how stocks have performed in the six months following those readings. The biggest gains by far have come after investors were positioned the most defensively.
"When defensiveness has been in its upper quintile (as it is currently), the future six-month average annualized percent gain in the S&P 500 has been a stellar +18.63%, compared to only +7.55% the rest of the time," Paulsen writes.
Somewhat remarkably, the chart also shows that the market is much less likely to decline when the defensiveness indicator is especially high than it is when it’s lower. It implies that during highly defensive periods, investors may be able to expect the best of both worlds.
To Paulsen, that suggests that defensive positioning works, and that if the market does suffer a downturn because of a blowup in trade talks or some other event, it probably won’t be that severe.
"If a bear market were to start today, most investors are ‘acting’ like this is fully expected and are already prepared," he said.
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