Extreme Fear is Now Driving Markets

On October 27th I wrote in Fear and Greed is Shifting and Models Don’t Avoid the Feelings that:

The CNN Fear & Greed Index shows investor fear and greed shifted to Extreme Fear a month ago as the popular U.S. stock indexes dropped about -12% or more. Many sectors and other markets were worse. Since then, as prices have been trending back up, Greed is now the driver again. I believe fear and greed both drives market prices but also follows price trends. As prices move lower and lower, investors who are losing money get more and more afraid of losing more. As prices move higher and higher, investors get more and more greedy. If they have reduced exposure to avoid loss, they may fear missing out.

Since global markets declined around August and some markets recovered much of their losses by November, global markets have declined again. Below are charts of U.S. stocks, International stocks, U.S. bonds, and commodities. Even the iShares iBoxx $ Investment Grade Corporate Bond ETF that seeks to track the investment results of an index composed of U.S. investment grade corporate bonds is near -8% from its peak. Small and mid companies U.S. stocks are down more than -20% from their peak. Commodities and emerging countries are down the most.

global markets 2016-01-15_13-59-45.jpg

This all started with investors being optimistic in late October as I mentioned in Fear and Greed is Shifting and Models Don’t Avoid the Feelings. So, it is no surprise that today is just the opposite. As markets have declined investors become more and more fearful. As of now, Extreme Fear is the driver of the market.  Below is the current reading of the CNN Fear & Greed Index.

Fear and Greed Index

Source: CNN Fear & Greed Index 

As you see in the chart below, it’s now getting close to the Extreme Fear levels that often signal at least a short-term low.

Fear and Greed Over Time

Another publicly available measure of investor sentiment is the AAII Investor Sentiment Survey. The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The most recent weekly survey shows investors are very bearish and again, such pessimism occurs after price declines and at such extremes sometimes precedes a reversal back up.

Survey Results for Week Ending 1/13/2016

AAII Investor Sentiment January 2016

Source: AAII Investor Sentiment Survey

I say again what I said in October: This is the challenge in bear markets. In a bear market, market prices swing up and down along the way. It’s these swings that lead to mistakes. Above was a chart of how the Fear and Greed Index oscillates to high and low points over time. Investors who experience these extremes in emotion have the most trouble and need to modify their behavior so they feel the right feeling at the right time. Or, hire a manager with a real track record who can do it for them and go do something more enjoyable.

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