The Cycle of Optimism: 2 Years Up, 2 Years Down?

Hey guys, Brian here. I hope your week’s going great.

There’s an interesting two-year cycle of peaks in optimism that’s been going on for about six years now. In this video, I’m gonna show you this cycle because, if it is still operative, we’re in a time window right now where we could see a big surge in negative sentiment. Stay with me.

All right, guys, welcome back. Real quick, before we look at this cycle, let me just show you where I’ve been the last few weeks. I’ve been traveling around Hokkaido, in northern Japan, and this is the view coming down the ropeway of Mount Hakodate — very, very cool little city. I really loved it here.

There’s some interesting financial history here, too. Hakodate was one of the first Japanese ports to open to international trade in 1854. There was a convention that ended Japan’s period of isolation. Hakodate that saw this, you know, influx of foreign traders, and it was a big historical event that really played a major role in modernizing Japan’s financial system.

The other interesting thing is that Hakodate was the capital of Japan’s first attempt at a Republic — the Republic of Ezo. A group of Samurai rebelled, tried to set up a Western-style democracy. It lasted five months, and was overthrown in 1869. But for the time, it was a huge departure from feudal Japan and toward a modern governance system. So, super interesting place. Really glad I got a chance to visit.

Let’s take a look at this cycle. Top graph here is the Dow, bottom graph is the VIX Implied Volatility Index. We have inverted this to align with stocks. So the top’s in the blue graph here. Our low VIX readings, which show high complacency, extreme optimism, right? Those readings align very well with peaks in the Dow. As they should, right?

The cycle here is fairly clear, right? Every two years — 2018, 2020, 2022 — the inverted VIX, it hits a cycle high that coincides with a high in the Dow and that leads to some kind of selloff.

So, I’m bringing this up now because this cycle is due to reverse again. The window was November to January. So, we’re on the tail end of that turn window.

The cycle is especially compelling right now because of some other indexes that show what I’ll just call dangerous levels of optimism. This is one of them.

Steve and Pete published this chart in the January Financial Forecast. (Subscription link’s below.) It’s the bullish percent in the weekly AAII poll — famous poll showing expectations of retail investors. So, this is not institutions. It’s mom and pop.

Bullish percent just hit 61%. That’s the highest percentage since the first quarter of 2021. And that, if you remember, is when the mania in SPACs ended, when the IPO mania ended, when the mania in meme stocks reversed. That’s where we would have to go to find a time when mom and pop were more enthusiastic than they are today.

The behavior of retail traders, it’s a contrary indicator, and their commitment to the market is extreme. And we think it’s going to change dramatically during the next wave of declines.

Let me know what you think in the comments. Again, subscription links below, if you’d like to see more of this kind of analysis. And thanks for watching.