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Category: Sentiment Updates

The VXX Volatility Index is Warning of a Stock Market Correction

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.

The VXX Volatility Index is Warning of a Stock Market Correction
The VXX Volatility Index is Warning of a Stock Market Correction

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.

The VXX Volatility Index is Warning of a Stock Market Correction
The VXX Volatility Index is Warning of a Stock Market Correction

Investor Sentiment Stock Market Indicators Ringing Warning Bells

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.

Investor Sentiment Stock Market Indicators Ringing Warning Bells
Investor Sentiment Stock Market Indicators Ringing Warning Bells

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.

Investor Sentiment Stock Market Indicators Ringing Warning Bells
Investor Sentiment Stock Market Indicators Ringing Warning Bells
Investor Sentiment Stock Market Indicators Ringing Warning Bells
Investor Sentiment Stock Market Indicators Ringing Warning Bells

Sentiment Indicators Turning Negative as Investor Optimism Grows

We use investor sentiment as contrarian indicators on market direction since investors are usually wrong. During the past week the indicators were showing increasing investor optimism for the near term and the intermediate term. And that’s a warning signal for smart investors to watch out.

Short term sentiment indicators have now started to issue negative warning signals as investor complacency grows. The VXXB is now at a two-year low showing no sign that the market place is expecting future volatility. The CNN Fear Greed Index is trending higher in the greedy zone at 68.

Sentiment Indicators Turning Negative as Investor Optimism Grows
Sentiment Indicators Turning Negative as Investor Optimism Grows

Intermediate term sentiment has also moved to the negative side as contrarian indicators. The Smart Money/Dumb Money confidence gauge has moved to multi year lows showing that most of the marketplace is now getting bullish.    The Investors Intelligence Bulls/Bears poll of stock market newsletter writers shows bulls at 54% bulls and 19% bears. This makes the spread positive 35% which is optimistic and a negative. Plus 40% is a red alert warning sign, and we have been grinding our way toward that.

Investor Stock Market Sentiment Indicators Flashing Warning Signs

We use investor sentiment indicators as contrarian indicators on stock market direction because investors are historically wrong. The CNN Fear & Greed Index has moved up to 70, showing short-term sentiment has gotten bullish, a negative sign for the stock market.  Meanwhile, the VIX volatility Index is as low as it was before last year’s 4th quarter selloff.

Investor Stock Market Sentiment Indicators Flashing Warning Signs
Investor Stock Market Sentiment Indicators Flashing Warning Signs

Intermediate sentiment also has become more optimistic. The Investors Intelligence Bulls/Bears poll of newsletter market writers is 54% bullish and 19% bearish.  That’s a spread of 35% between the two, which is another warning sign.

Intermediate-Term Stock Market Sentiment Indicators Flashing Warning Signals

We use sentiment Indicators as important guidance on stock market direction. Intermediate-term indicators are telling us to take defensive positions. The Investors Intelligence Bulls/Bears poll of newsletter writers indicates bullish sentiment greatly outnumbers bearish sentiment with a positive spread of +32. That’s a clear warning sign because these writers historically have been wrong about market direction. Meanwhile, the WWW.Sentimentrader.com Smart Money/Dumb Money Confidence Spread which measures the activity of competent vs. incompetent traders, is unfavorable at below -0.25.

Intermediate-Term Stock Market Sentiment Indicators Flashing Warning Signals
Intermediate-Term Stock Market Sentiment Indicators Flashing Warning Signals

Another note of caution comes from the S&P 500 VXX ETN, which we use as contrarian indicator. It is at the lowest level since early October when it missed forecasting the big fourth quarter market drop. In other words the VXX is showing the same level of complacency, suggestive of no expectation of future volatility, as it was before the big fourth downturn.

Intermediate-Term Stock Market Sentiment Indicators Flashing Warning Signals
Intermediate-Term Stock Market Sentiment Indicators Flashing Warning Signals

Meanwhile, the CNN Fear/Greed has backed off to a neutral 47. That means there’s no real way of reading it in terms of short-term market trends.

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