“Greed, for lack of a better word, is good” – Gordon Gekko, Wall Street (1987)

With all due respect to Gordon Gekko, when it comes to investing it is not greed but fear that is good. Fear creates opportunity and a favorable balance between risk and reward. Greed inevitably leads to poor decision making and chasing higher risk investments with little reward.

For the better part of the past year and a half, greed has been the dominant emotional state amongst investors. The “wall of worry” that had persisted throughout the early years of the bull market was torn down. In its place: greed and the strongest emotion of all, the fear of missing out.

As I wrote last December, investors had gone “all-in” on U.S. equities and were exceedingly optimistic about future returns. In the past, this has led to below average future returns which is indeed what we have seen through the first nine months of 2015.

But today, after the largest S&P 500 correction (12.5%) since 2011, the emotional landscape is shifting. Fear is emerging as investors have come to learn that U.S. equities are not risk-free.

  • Bears outnumber Bulls in the Investors Intelligence survey for the first time since 2011.
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  • The ratio of puts (bearish bets) to calls (bullish bets) is at its highest level since 2012.
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  • Active Managers have reduced their net long equity exposure to 16%, down from 99% back in February.
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  • Fear in Emerging Markets such as Brazil is approaching historic levels, and has pushed prices back to their 2008 lows. We are told that there is not one good reason to invest in Brazil today which from a sentiment standpoint exactly what you want to hear.
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    This increasing fear is a good sign as forward returns are generally above average when investors turn exceedingly bearish. This is another way of saying that the short-term balance between risk and reward is improving for the first time in a while.

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