Sentiment Report: The Fear Factor
It took a while, but the bulls were finally brought down to earth after 13 months of straight-up action.
And sentiment was remarkably positive from December 2017 until last Friday when volatility exploded, leading to the VIX spiking over 50 on Tuesday morning.
It's common for the market to top out when sentiment gets to extreme levels. But it actually took 2 whole months for that to happen during this once-in-a-life-time stretch of happiness!
Now, let's take a look at how the mood has changed using our handy dandy sentiment indicators.
(click here for a primer on the sentiment indicators below)
1) VIX Spread – Bearish
As of Friday morning, the VIX was hovering right around 30. It was actually under 10 in early January, so this is a major change.
And the 50.30 spike high matched the 53.29 high set in the August 2015 mini-crash.
The 3-month VIX spread is completely blown out at around -10. This means traders are very bearish and expect a lot of volatility.
(click here for a primer on the VIX spread)
2) CNN Fear & Greed Index – Bearish
The Fear & Greed Index is at 8, down from 59 last week.
This index operates on a 0-100 scale, and a reading of 8 means traders are very fearful (or bearish).
This is a shocking change. Fear & Greed was at 76 just a month ago.
3) AAII Sentiment – Neutral
The American Association of Individual Investors' Sentiment Survey shows that 37% of those surveyed are bullish. This is down from 44.7 last week.
The long-term average is 38.4%, so this is basically neutral.
Interestingly, this indicator was mostly neutral in 2017, and only turned bullish in January 2018 — implying that individual investors were a bit late to the party.
4) CBOE Equity Put-Call – Bearish
The long-term average of the CBOE equity put-call ratio is 0.654.
And from December 7, 2016 to February 1, there wasn't a single day above that long-term average, which means there was an above-average level of call buying.
The trend changed on Friday, February 2.
Since then, the CBOE equity put-call has averaged 0.736, which means a sudden increase in demand for put options.
A single-day reading around 1 would indicate extreme fear, and we're not even close to that yet. In the past 5 days of volatility, the highest reading was 0.77. So options traders are bearish, but only moderately so.
Conclusion
Out of 4 sentiment indicators, we have:
- 0 bullish (down from 4 last week)
- 1 neutral (up from 0 last week)
- 3 bearish (up from 0 last week)
On October 6, I made the following melodramatic declaration:
Let's not mince words: the bulls are clearly insane. They think they're destined to ride into the sunset on a magic carpet made of cold hard cash. I can see both sides of the coin here. The bulls may be insane… but they may also be right. Timing market turns based on sentiment indicators is awfully tricky. And remember, the trend can go on a lot longer than may seem reasonable.
I threw in that sentence “Timing market turns based on sentiment indicators is awfully tricky” for a very good reason.
These indicators are for color. They are only one part of the investment process, not signals on their own.
Turns out that sentiment indicators were not very helpful in calling the 2018 top, because they've been very bullish since early December.
So unfortunately, they may not be helpful in calling the bottom either!