We use investor sentiment as contrarian indicators about the direction of the stock market. Short-term and long-term indicators this week were giving mixed messages, which tells us to remain cautious. The CNN Fear/Greed short term sentiment Indicator moved from a very greedy 62 at the beginning of May down to 28, which is a positive signal for the stock market short-term.
However, contrast that with the VXX volatility index (see chart). It has yet to show the kind of upward move to suggest a low could even be in sight.
As for the intermediate term, the Investors Intelligence Bulls Bears poll of market newsletter writers moved from 57% bulls to 50%. That’s a positive move from a contrarian point of view. However, bullish sentiment remained at 18%. History has shown us that bearish sentiment needs to climb to 30% or higher before we can call a durable stock market bottom.
Chart provided by https://www.investorsintelligence.com
Short-term investor sentiment indicators were back down in overbought territory late week after showing some initial investor nervousness earlier in the week amid the uncertainty over US-China talks that triggered a sharp market drop.
The VXX volatility index, for instance, moved higher then started down again later in the week, indicating that investors were betting on lower volatility. That’s a signal for caution since we used sentiment as contrarian indicators.
We use investor sentiment as contrarian indicators for determining market direction. The indicators in past weeks have been warning that the stock market would remain highly volatile because investors, who historically are wrong, were overly optimistic. Sure enough, confirming the market’s vulnerability, Trump’s China tariffs triggered this past week’s retreat. So is this a time to buy? Not according to the sentiment indicators.
That’s because despite the downturn, sentiment indicators haven’t moved at all, remaining in overbought territory as investors remain complacent, seemingly unphased by the drop.
For example, the Investors Intelligence Bulls/Bears poll of stock market newsletter writers shows bulls at 55% and bears at 18% with the spread between the two at 37. That’s virtually unchanged from the previous week. Bullish sentiment at 55% means high risk for investors, and 60% calls for major defensive action.
Meanwhile, the VXX volatility Index at around 25 remains at a multi-year low, indicating investors are very complacent compared to last December at 45 to 50 when it was signaling the market was oversold at about the time of the year-end market drop.
The way professionals play the sentiment indicators is not to be ahead of them, but rather to follow them to wait for the next time the indicators reach extremes indicating it is time to buy or sell. We will continue to monitor sentiment in the coming weeks as important lead indicators.
We use investor sentiment as a contrarian indicator about stock market direction. The VXX Volatility Index , which is a measure of short-term future stock market volatility, is a particularly helpful sentiment indicator, and also is a way to illustrate how more emotional and volatile the stock market has become in the last 18 months. The VXX presently is at a multi-year low, indicating investors have become very complacent.
That’s proved to be an important warning sign of stock market corrections from a contrarian point of view for the past 18 months. Here’s why:
–VXX-related products blew up in February 2018, and the market went from an overbought position into a correction. As a result, investors became very fearful, and the market became oversold as investors headed for the sidelines.
–And that set the stage for the 2018 spring-to-fall rally marked by new market highs, which led to investor complacency despite the fact that the market had become overbought.
–Not surprisingly, that set the stage for last year’s fourth quarter correction, which once again sparked end-of-the world investor fears. Which was a good indicator of an overbought market. Not surprisingly, that was followed by this year’s major rally.
So what’s next? Once again, the VIX is telling us that investors have become extremely complacent, and the market has become overbought. Which once again is a good indicator of a major correction and more volatility than market participants are anticipating at this point.
What are other sentiment indicators telling us? The short-term CNN Fear/Greed index at 62 is in greedy territory but hasn’t change much from the previous week. However, intermediate sentiment indicators have become decidedly more bearish from a contrarian point of view.
For instance, the Smart Money/Dumb Money confidence gauge has moved to multi year lows showing that the marketplace is getting overly bullish, yet another negative in terms of market direction. Meanwhile, the Investors Intelligence Bulls/Bears poll of stock market newsletter writers shows bulls at over 56% compared with 53% a week ago and bears down to 17%. Bullish sentiment over 55% means higher risk for investors, and 60% calls for major defensive action.
History shows us that most investors get stock market turns absolutely wrong. That’s why market professionals use investor stock market sentiment as contrarian indicators, so they won’t be part of the herd. And those indicators have shown growing investor optimism about market direction and increased complacency about future volatility. Which are warning signs to take defensive action.
Among short-term indicators, the CNN Fear/Greed Index moved higher into greedy territory to 71. That means investors are becoming increasingly emotional and less rational about the chances of a stock market downturn. Another short-term warning of increasing investor complacency comes from the VIX volatility index which is at a multi-year low.
As for the intermediate-term, the Smart Money/Dumb Money confidence gauge has moved to multi year lows showing that the marketplace is getting overly bullish, yet another negative . The Investors Intelligence Bulls/Bears poll of stock market newsletter writers shows bulls at 53% and bears at 18%. That’s a plus 37% spread between the two. What does that mean? Plus 40% is a red alert warning sign, and we are getting closer to that.