WHEN TO SELL YOUR INVESTMENT?
Ultimately, an investor’s return is the sum of the dividends received and
the difference between the buying and selling prices over the duration
of the investment. A lack of effective selling strategies can even
undermine the efforts of investors who are the best at finding
undervalued stocks.
A security is overvalued when the market judges the business to be
more valuable than the underlying data indicates. Overvalued
securities can stay overvalued for some time, but markets eventually
correct. There are some signs to watch out for. Overvalued securities
usually have a lot of good news and lofty expectations already baked
into their prices and high hurdles to beat. Should these businesses
disappoint investors, their prices could rapidly drop, leaving an
investor with a loss.
three key indicators that signal increased risk appetite in the market:
1. Consumer Discretionary vs. Consumer Staples Stocks
One of the most reliable indicators of risk-on sentiment is the ratio of
consumer discretionary (NYSE:XLY) to consumer staples (NYSE:XLP).
Consumer Discretionary Vs. Consumer Staples
Historically, this ratio has signaled major turning points in the market.
For instance, the ratio peaked in late November 2021, hinting at the
market’s shift just before the 2022 bear market.
Similarly, it bottomed in December 2022, two months before the
broader market confirmed the start of a new bull cycle.
Lately, we’ve seen this ratio oscillate, but recent action suggests risk
appetite is rising again.
A decisive break above the 2.5 resistance level would be a strong
bullish signal, indicating investors are willing to take on more risk. If
this ratio hits a new high, it would confirm continued bullish
momentum.
2. Credit Spread Movements
When markets face pressure, credit spreads tell the story.
These spreads reflect the risk premium investors demand for holding
debt from less stable companies. In times of fear or volatility, high-
yield bonds (NYSE:HYG) are often the first to get sold off, widening the
spread.
High-Yield Bonds Vs. Treasuries
After a brief period of heightened fear in August and September, credit
spreads have tightened again, suggesting investors are more
comfortable with risk.
The spread between high-yield bonds and safer options like the United
States 10-Year has not only rebounded but has also surpassed
previous highs from earlier in the year.
This trend supports the case for a bullish market, as shrinking credit
spreads indicate investor confidence in riskier assets.
3. High Beta Stocks’ Momentum
The ratio between high beta stocks (NYSE:SPHB) vs. low-volatility
stocks (NYSE:SPLV), known for their volatility, often provide a clear
signal of risk appetite.
This ratio hit its peak in mid-July 2024, before stalling out. Although
high beta stocks have rallied since their September low, the ratio
hasn’t reclaimed its July highs, even as the S&P 500 continues to notch
new records.
SPHB Vs. SPLV
This divergence between high beta stocks and the broader index
typically doesn’t last long—one will correct to follow the other.
In the weeks ahead, it will be crucial to watch whether the high-beta
stocks vs low volatility stocks ratio regains momentum. If the ratio
starts climbing again, it could reaffirm a short-term bullish outlook.
These three indicators—consumer discretionary vs. staples, credit
spreads, and high beta stocks—offer valuable insights into where the
market might be headed. Keep an eye on them to gauge risk sentiment
and position yourself accordingly.
