Biggest Risk For Stocks = Urgency To Buy Increasing With Price

Updated on


Trailing 12 Month Sharpe Ratio = True “Tell”


There Is Plenty Of Chatter About The U.S. Equities Markets & How Extended They May Be.

So Often I Am Asked About A Catalyst To Initiate A Meaningful Price Reversal. I Wish I Had An Easy Answer. It Could Be Many Things…Almost Anything. But Actually The Catalyst = Almost Irrelevant.

What Resonates With Me The Most, Though, Is The Multi-Year URGENCY To Buy Equities…As Measured By A Lack Of Any Meaningful, Peak To Trough, Capital “Draw-Down” Since February 2016.

The BTFD Mentality Continues To Prevail And Is Increasingly Acute…As The Price Dips Are Less Frequent + Increasingly Brief + Shallow.

Meanwhile…Stock Prices Regularly Reach New All-Time Heights.


Do you know which under-the-radar stocks the top hedge funds and institutional investors are investing in right now? Click here to find out.

The Market’s Elasticity Seems Stretched Very Close To Its Limits…But Still…Prices Continue To Surge At A Steepening Rate…Thanks, Primarily, To The Seemingly Open-Ended/Massive Liquidity Measures Offered By Global Central Banks [QE, ZIRP, NIRP & IOER In The U.S.].

That These Liquidity Measures Also Dilute The Currencies, In Which Equities Are Specifically Denominated, Further Confounds The Parabolic Equity Advance.


The Monthly Chart Of The SPX [see above] Visually Demonstrates The Relentless Price Thrust Higher.

Furthermore, That The S&P 500’s Total Return Was Positive For Every Month Of Calendar 2017 = Simply Stunning…Resulting in 19.38% Return [ex:dividends].

Even More…Since March 2016…20/22 Months Have Yielded Positive Returns. And The Absolute Returns = Awesome = 41.25% [ex:dividends].

Fundamentally…Earnings Per/Share For The S&P 500 Constituents Have Improved But, More Importantly, The EV/EBITDA Multiples Have Also Strongly Advanced…Offering Much More Fuel To Prices Than The Decent Earnings Increases.


But What Makes The Market Return Profile Especially Remarkable…Is Not The Impressive Percentage Gains [bull markets have yielded many similar results over the past century]…But The Lack Of Volatility…As Measured By The Standard Deviation Of Prices Associated With These Returns.

It Is The Before Mentioned BTFD’ers That Perpetuate The Lack Of Standard Deviation/Volatility.

Of Course The BTFD Behavior Is Shaped By Central Banker Behavior…That Encourages Massive Risk-Taking…Despite The Unprecedented Price Climb.


So How To Measure/Quantify Any Of This?

The Sharpe Ratio Is The Gold Standard To Measure/Quantify This Feature As It’s Quotient Incorporates Standard Deviation Of Returns In Its Denominator.



It Essentially Communicates The Mathematical Pathway To Returns…How Much Capital “Draw-Down”/Pain Was Endured To Achieve Returns.

And Historically…There Is Usually A Fair Amount Of Pain On This Path…Despite Monumental Efforts To Avoid Such Pain.

The Higher The Value Of The Sharpe Ratio = The Better The Return Profile As The Sharpe Ratio Assigns a Higher Value On “Risk-Adjusted Returns” Vs. “Absolute/Plain Returns”

Be Advised, Though, That A Higher Sharpe Ratio Value Does Not Necessarily = Higher Absolute Returns.

To The Contrary…A Higher Sharpe Ratio [especially valued at hedge funds] Typically Equates To Lower Absolute Returns…As The Pursuit Of Pain Avoidance Consequently Results In More Dampened Total Returns.


On The Other Hand “Long-Only” Mutual Funds + Passive Indexed Strategies Usually, Over Longer Time Frames, Cannot Avoid A More Muted Sharpe Ratio [versus hedge funds] As They Are Wholly Exposed To Downside Volatility [fully invested mandate]…That Is…UNTIL RECENTLY…As The Data Set Below Demonstrates.

S&P 500
Month End 12.17

Sharpe Ratio
1-Yr 4.36
3-Yr .88
5-Yr 1.35
10-Yr .45
15-Yr .53

Standard Deviation
1-Yr 3.89
3-Yr 10.04
5-Yr 9.46
10-Yr 15.08
15-Yr 13.26


The 1 Year Data = STAGGERING…Not Only Because Of The Stratospherically High Sharpe Ratio of 4.36 [driven by both a strong numerator + puny denominator] But Because It Is Associated With A Long Only, Non-Levered Passive Strategy…Producing Close To 20% Returns.

Remember…Higher Sharpe Ratios Are Typically Linked To Lower [Not Higher] Absolute Returns.

Plus, These Recent Results Stand On The Shoulders Of A Market Low Achieved Almost 9 Years Ago.


So…Is The Sharpe Ratio Just Another Indicator Rendered Useless By Money Printing Central Bankers?

I Think Not.

What The Current Sharpe Ratio Actually Speaks To = Market Participants Recklessly Sprinting Into A Mature Bull Market….Pointing To An INCREASING PROBABILITY OF A LARGE PRICE DECLINE…NO MATTER THE CENTRAL BANKER REACTIONARY TACTICS.


Contact The Author: [email protected]

Signup to ValueWalk!

Get the latest posts on what's happening in the hedge fund and investing world sent straight to your inbox! 
This is information you won't get anywhere else!