In previous articles, we discussed ways to spot stock market tops. We already covered macroeconomic indicators, interest rate cycles and valuation metrics. Here we will cover market sentiment indicators and what they tells us about the current market.
1. Bulls vs Bears surveys
One common way to assess market sentiment is through surveys which ask investors to describe their short-term market outlook.
Source: Investor Intelligence, Yardeni
Currently, with 58.5% of investors feeling bullish, market sentiment is very positive, and has been rising for the past year. Taken by itself, this might indicate excessive optimism in the current market, which may change quickly if earnings disappoint.
2. Volatility index (CBOE VIX)
This volatility index gives us investors’ expectation of risk for the next 30 days. As we can see from the chart below, risk expectations are close to all-time lows.
Volatility Index (Black) vs S&P 500 (Green)
With such low values, expectations of risk may be about to bottom. Even if that is the case, since this indicator was created, the market always peaked at a higher value. Therefore, there is likely more room for price increases until the market starts to turn.
3. S&P 500 Put to Call ratio
Put and Call options are instruments investors use to benefit from either increases or decreases in market prices. Put options are used to bet on price decreases and Call options to bet on price increases. Therefore, a high Put/Call ratio indicates market pessimism, and vice-versa.
Source: Yardeni 2017
When the ratio turns below 1, it might indicate excessive investor optimism about the stock market. That is, when we might be nearing a market top. At the moment, however, this ratio is close to the long-term average of 1.62.
4. Short Interest
Another good indicator of investor sentiment is the amount of shares in a short position (the amount of shares that investors borrow in anticipation of price declines).
As we can see from the chart below, there has been a significant change in sentiment since 2016, enhanced by the US presidential election, with a sharp decline in short interest. However, short selling is still close to the average of the past decade, indicating that investors are not overly optimistic.
New York Stock Exchange (NYSE) Short Interest vs S&P 500Source: Raymond James, as of May 1 2017
Overall, we see that investor sentiment is slightly on the bullish side. This does not mean that the market is about to peak, but it implies that investors should pay more attention to earnings releases to check if expectations are met.
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The information contained in this article is General in nature and has been prepared without taking into account your objectives, financial situation and needs. When assessing any investment you should also consider that past performance is not a reliable indicator of future performance