Measuring Complacency in the Markets

by: Doug Carey

Was March 2009 really that long ago? Less than two years ago the S&P 500 was sitting at 683 and the S&P 500 implied volatility index, the VIX, was just coming down from its peak of 80.

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Now the VIX sits at 16.1 as of today, an 80% drop from late 2008, and the surveys show the lowest number of bearish investors (19%) since January, 2006. Meanwhile, interest rates continue their steady upward climb, states and cities across the country are about to lose their Build America Bond subsidies, Europe’s financial system is being held together by the equivalent of bailing wire and chewing gum, and the United States government continues to spend like the day of reckoning will never come.

So what does this mean for everyday investors? First, it shows just how much psychology determines the level of the stock market. The madness of crowds works in both directions. Second, it pays not to get caught up in the madness, whether that is a stock market plunge or a market rally sending PEs well past their 20 year average. Third, it’s always a good idea to have some cash on hand for the inevitable correction. And lastly, do not become complacent. It would be a shame for people to forget how we got into the financial mess we are in. It pays to always be vigilant and to never chase after returns just because so many others are doing it. Gambling is best left for Vegas. Investing requires discipline.

This country is in for a rough ride and plunging all of your money back into stocks while everybody else is becoming complacent is the worst thing to do. At the very least it is prudent to diversify your wealth, invest in companies with solid balance sheets and reasonable valuations, and hold at least some gold, preferably physical.

Disclosure: I am long GLD and own call options on the VIX.