Equity Strategy: September 2012 Chart of the Month

• The Panic/Euphoria Model has moved back into complacency. The closely watched sentiment gauge is beginning to warn of an investment community that appears to have become complacent again, as was the case in late March/early April 2012 and in April/May 2011 right in front of equity market wobbles. With September historically being a challenging month for stocks, such signals should be carefully monitored.'

• Markets tend to be accident prone when investors get too comfortable. A variety of issues need to get resolved for equity markets to gain further traction and thus possible reliance on some form of QE3 or increased ECB action may be the forces providing fund managers with the notion of a risk backstop. Current readings of investor emotion and positioning imply a somewhat more cautious stance may be appropriate given the potential for some disappointment, but not all signals are flashing yellow yet.

• Sentiment is still far from euphoric and thus one should not expect a new bear market. Euphoria levels generate an +80% probability of down equity markets in the subsequent year (based on the backtest), which is extraordinarily high given that there is a 70% random chance of markets appreciating in the subsequent year, after buying the index on any given day. Thus, the current level of complacency alone is not overly disconcerting.

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