Whenever you hear people making predictions about what will happen in markets I would advise you to grab your money and slowly back away. Next, run as fast as you can in the opposite direction. Let’s take a look at a few market indicators and go beyond the CNN Fear & Greed Index.
While it’s not a great idea to think you can predict what will happen in markets, one thing you should know is where we stand today and where we’ve come from. Investors are primarily driven by two emotions, fear and greed. When investors are greedy the prices for assets can get bid up way beyond what is a reasonable and fair price. When there’s too much fear in markets prices can sink below where they should be and great deals can be had. An interesting index I’ve watched is the CNN Money Fear & Greed Index. This is not a predictor of the future and certainly not a trading device for timing markets but an index combining 7 useful indicators of investors appetite for risk or lack thereof can be informative.
The CNNMoney’s Fear & Greed Index looks at 7 market indicators. Each indicator is tracked for how far they are from their average. The index uses a scale from 0 to 100 with the higher the reading the higher the greed of investors with 50 as neutral. Back in the depths of hell during the financial crisis in September of 2008 the index rang in at a fearful 12. Later when cooler heads would prevail and the economy began to recover in 2012, stocks and markets in general began to go on a epic run where the CNN Fear & Greed index would skyrocket to the upper 90’s.
So what goes into a simple gauge of investor emotion? There are literally hundreds of indexes and indicators you could choose to show the everyday ebb and flow of money in global markets. CNNMoney’s Fear and Greed chose 7 indicators to blend into their index recipe.
Stock Price Strength is the number of stocks on the New York Stock Exchange hitting their 52-week highs. If there’s more stocks hitting new highs than stocks hitting new lows it would indicate greed in the markets. At the moment there are 165 new 52-week highs on the NYSE and only 23 new 52-week lows. You can find the complete list of companies here, but as you can see in the chart above the index is in Extreme Greed territory as the NYSE is showing stock price strength currently.
Market Momentum is the S&P 500 index versus its 125-day moving average. This is simply how far above or below stocks are from their not to distant past. The higher the S&P index gets from the 125-day moving average, the higher it scores on the Fear & Greed rating. On the other hand when fear strikes and the S&P plummets below it’s 125-day moving average the lower score will compute as fear into the Fear & Greed Index. The index also breaks down the most recent analysis and gives the previous reading and the date the last reading occurred.
Safe Haven Demand is the difference in 20-day stock and bond returns. When stocks outperform bonds over the last 20 days it indicates an appetite for riskier assets therefore a more greedy atmosphere in the financial markets. Bonds are considered a safe haven and when fear strikes bonds are more desirable and stocks would go down. At the current reading stocks are outperforming bonds by close to the strongest margin over the last two years indicating more greed and less fear in general.
In times of market turbulence a safe haven is an investment that retains or increases it’s value. You may be asking yourself why bonds are considered safer than stocks and the answer is not always clear. One of the most common answers would be the fact that corporate bond coupon payments are considered more stable than company dividend payments.
Another useful indicator in markets for gauging the optimism or pessimism at a given time is the Put to Call Ratio. The CBOE 5-day average put/call ratio tracks the daily volume of options purchased showing sentiment among traders. This ratio is known as a contrarian measure where too many call option buyers would signal a market top may be in the making. If traders buy too many put options the possibility of a market bottom is more likely.
A useful exercise is to look at a long term chart of the Put/Call Ratio and see where the index registered at market extremes. One thing to keep in mind is that historically the option index has been skewed toward more put buying that call buying because of hedging by portfolio managers. At the current reading the volume of put options has lagged volume of call options by over 37%. This happens to be the lowest level of put buying over the last two years making showing greed in markets.
Stock Price Breadth shows volume in advancing stocks relative to declining stocks. The McClellan Volume Summation Index tracks advancing and declining volume on the New York Stock Exchange over the last month to indicate strength or weakness. Over the last month 12% of each day’s volume on the NYSE has traded in advancing issues rather than declining issues showing an appetite for greed over fear.
The VIX along with it’s 50-day moving average can reveal extreme fear among investors. It’s the expectation of market volatility implied by the S&P 500 index options and calculated on a real-time basis by the Chicago Board Options Exchange. If the VIX is above it’s 50-day moving average investors fear may be increasing and if the index falls below it’s 50-day moving average the market is showing a less fearful atmosphere. Market crashes and panics have coincided with a spike in the VIX to extreme levels showing the height in investors fear.
When investors look to riskier investments like junk bonds it can indicate a greedy atmosphere. The Yield Spread tracks junk bond demand vs. investment grade corporate bonds. Buyers are paid a higher yield for junk bonds because the risk of default is higher for junk bonds relative to investment grade bonds. When the yield spread falls it shows an appetite for risk because investors are less worried about default and greedy for higher returns by accepting less compensation for more risky junk bonds. A fearful market would demand a much higher yield on junk bonds relative to investment grade bonds and therefore send the yield spread higher.