Maximum Fear May Be Near

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Includes: SPY, VXX
by: David I. Templeton, CFA

To say the least it has not been a rewarding start for investors in the equity markets so far in 2016. After the volatile downside move in equities today, the S&P 500 Index closed at 1,880, down 8% year to date. Intraday today the S&P 500 Index was down 3.3% and pierced the August low of 1,867 and finally closed down 2.1%. The market action has raised the investor fear level to near oversold levels, if not to a maximum oversold level.

The equity put/call (P/C) ratio spiked above 1.0 to 1.14. As I have noted in earlier posts, P/C ratios above 1.0 are representative of an oversold market. The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment by the individual investor.

From The Blog of HORAN Capital Advisors
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A week ago I wrote about the VIX futures curve being in backwardation. Steeper backwardation has occurred after the market action today. Backwardaion took place near the market bottom on August 25, 2015. VIX backwardation is an indication traders expect volatility in the future to be lower than it is now. Historically, when this occurs, short term market rallies tend to result from this technical event.

From The Blog of HORAN Capital Advisors
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Further, individual investor bullish sentiment fell four percentage points to 17.9% as reported by the American Association of Individual Investors earlier this week. The last time the reading was near this level was April 14, 2005 when bullish sentiment was reported at 16.5 and the S&P 500 Index was trading at 1,173. Investor sentiment is a contrarian indicator and this level of market pessimism is another sentiment measure that may mark another interim market bottom.

From The Blog of HORAN Capital Advisors
Click to enlarge


Scott Grannis, writer of the Calafia Beach Pundit blog and former Chief Economist at Western Asset Management, highlights other fear measures that readers may find useful in reviewing. His recent post includes commentary on the stress in the bond market and notes the higher liquidity in the markets today versus in 2008. As with most market sell offs, elevated fear levels are the fuel to the fire, yet can result in a market that becomes too oversold.