Why investor caution is a reason for market optimism

The amount of cash on the sidelines is a bullish signal that suggests investors will support more market pullbacks.

John Christofilos, senior vice-president and chief trading officer at AGF Investments Inc, said that many had learnt from 2008 and previous crashes, which meant there was a residual sense of trepidation around the markets. That, he said, was a cause of optimism going forward, with research pointing to that fact investors are sitting on cash reserves waiting for opportunities.

He said: “That’s optimistic because typically when people are fully invested it’s a bearish signal because there are so optimistic they think the market is only going one way, which is higher. When they are under-invested and sitting on cash, that’s very much a bullish signal that they are looking for opportunities. When that opportunity comes, they typically put that money to work.”

Christofilos said this echoes behaviour over the past eight or nine years, where every drop – 5%, 7% or 10%, for example - resulted in money coming in to support the market, meaning a major downturn has been avoided.

He added that, from a trader’s perspective, if cash levels remain high and every pullback is bought, he envisages the market can “grind higher over the next little while”.

The backdrop to this is the painful memory of 2008 but Christofilos said that the industry is better equipped to guard against a crash, highlighting how exchanges had introduced circuit-breakers and that people’s understanding of risk was better.

He said: “Depending on your age, you’ve probably lived through two of these [crashes], in 2001 and in 2008. So unless you’ve gone completely senile and don’t remember those years, you are going to have some fears and trepidation around the market.

“If you’re old enough like I am, you remember 1987. It’s only human nature to be a little bit cautious because, depending on your age, you may not be able to afford another major downturn in the market and have enough time to recover in time for retirement.”

This sense of wariness, said Christofilos, is a good thing and investors should look in the rear view mirror to get a better understanding of why things happened.

He said: “Keeping a little bit of cash on the sidelines looking for opportunities has never been a bad strategy in investing and I’m talking going back 100 years.

“Having available cash and being liquid enough to pay for bills or look for opportunities in the market has always been a good strategy to have; I personally use it myself in my own investing.”

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