FRENZY is here!

My Fear & Frenzy Sentiment Index, based on a set of well-known sentiment indicators is flashing very RED.

The chart below will look familiar to those who follow my work for True Insights. It's the Fear & Frenzy Sentiment Index that I use to gauge overall market sentiment. And the chart is very outspoken – investors have gone too far in their enthusiasm, pushing the Sentiment Index deep into Frenzy territory.

What is the Fear & Frenzy Sentiment Index?

I analyze 11 key equity sentiment indicators to provide a comprehensive understanding of market flows, technicals, positioning, and risk. By utilizing indicators such as the VIX Index, the AAII Investor Sentiment Survey, Moving Averages, and the Relative Strength Index (RSI), I transform this data into my proprietary Fear & Frenzy Sentiment Index.

The Fear & Frenzy Sentiment Index scoring methodology is uniquely designed to ensure that only indicators providing valuable information on future equity returns are included in the sentiment index. This approach effectively distinguishes indicators that are only effective at extremes from those that consistently provide valuable signals. It's important to note that, contrary to popular belief, only a few sentiment indicators consistently provide clear contrarian signals.

Why are we in Frenzy?

Three key sentiment factors have pushed the Fear & Frenzy Sentiment Index deep into Frenzy territory:

1. US retail investors are the most optimistic since early August.

Every week, the American Association of Individual Investors (AAII) asks a panel of US retail investors about their market outlook. I primarily focus on the net percentage of bulls (i.e., % bulls - % bears). The more enthusiastic US retail investors become, the worse the outlook for the US stock market.

2. Relative Strength Index

The Relative Strength Index (RSI) is the benchmark that many investors use to determine whether a stock or index is overbought or oversold. Above a value of 70 indicates overbought conditions. The chart below is pretty clear: the S&P 500 Index is overbought.

3. Complacency

I attempt to measure whether investors are complacent. One way to do this is by examining the difference between realized market volatility and the VIX Index, the implied volatility. If the VIX Index falls below realized volatility, which is usually not the case, it may indicate complacency. After all, investors expect future market risk to be lower than it is now. With the surprisingly low VIX Index, a lot has to go right to continue this trend.

Other factors pushing the Fear & Frenzy Sentiment Index toward Frenzy include the SKEW Index, a measure of perceived tail risk, and the Equity Put/Call Ratio. But what stands out is that only one underlying sentiment factor pushes the index toward Fear. And that is the percentage of stocks in the S&P 500 Index trading above their 200-day moving average.

Based on historical data, the Fear & Frenzy Sentiment Index suggests that the risk-return trade-off for stocks is currently very unattractive. So, even if you are very optimistic about stock markets – the advice from the Fear & Frenzy Sentiment Index would be to wait for a better entry.

Have a great weekend,

Jeroen