Fear of Greed

We recently read a great piece of research from our new favorite technical analyst – Frank Cappellin of Capp Thesis.

In recent years, market commentators have increasingly referenced a particular sentiment indicator: the CNN Business Fear and Greed Index.

We follow at least a half dozen newsletter writers who show it almost daily and have seen it in many more newsletters…

We think the graphic nature of it is what makes it so popular.

Here is the most recent reading from the indicator:

Without going into detail about the "readings" on the chart, there are some interesting insights.

First, it is amazing that this indicator currently shows us in the "FEAR" zone despite the fact that the stock market indices are hitting new all-time highs.

We were at "NEUTRAL" a month ago. This means that despite the money being made, sentiment has marginally deteriorated recently.

Second, looking back a year ago, the sentiment was quite different. As the stock market hit new 52-week highs, this indicator was in the "EXTREME GREED" zone.

That turned out to be an excellent contrary indicator as the stock market peaked in July before selling off for the next four months.

What we just did above is what we see more commentators do – analyze this indicator's reading.

What Frank did, though, was something we had never seen. He EXPLAINED the index.

This would seem like a logical thing to do, but we had never seen anyone do it before. It is even more surprising since the indictor's web page gives all the components.

Please check out the website to read the full explanation of the indicator.

It has seven components.

The Seven Components

1. Market Momentum

This looks at the S&P 500 relative to its 125-day moving average. If the stock market is well above that moving average, it is considered extended and in "greed" territory. If it were well below this moving average, it would be in "fear" mode.

You can see it right now, and—as we have discussed many times—the stock market is quite extended. This means it is likely to need to take a breather soon.

2) Stock Price Strength

This one compares the number of stocks at 52-week highs versus 52-week lows. They call this "Strength," but it could also be considered a measure of market "Breadth. "Breadth means how evenly distributed strength is in the stock market.

We are sure you have heard many comments about the weak breadth of the current stock market. This indicator shows that and, therefore, falls into the "Greed" zone.

3. Stock Market Breadth

Here, they use a technical indicator called the "McClellan Summation Index." It measures the volume of stocks going up versus those going down. Like the previous indicator, it shows that the strength in this stock market comes from fewer rather than more stocks.

4. Put and Call Options

This one uses the "Put/Call Ratio," which measures the number of puts bought versus the number of calls bought. Puts help protect against losses, while calls profit from stock gains.

This means if many more calls are being bought than puts, then investors are greedy. This one is flashing off the chart, similar to the extension from the moving average in the first indicator.

5. Market Volatility

The CBOE Volatility Index, or "VIX," is examined here. We have often discussed this indicator.

It operates as a potential contrarian indicator. Like our favorite technical indicator, the "relative strength index" or "RSI," it is more useful in oversold than overbought scenarios.

A very high VIX indicates much fear and a potential stock market bottom, while a very low VIX doesn't necessarily tell us that much. This one is in neutral right now.

6. Safe Haven Demand

In times of fear, investors run away from stocks and to the safety of bonds. This indicator looks at the relative performance of stocks versus bonds in the past few weeks.

Last year, bonds were crushed, and the stock market was hitting new highs. Currently, bonds are muddling around in a range, making the signal less emphatic.

7. Junk Bond Demand

This one shows how lower-rated corporate bonds are trading versus treasury bonds. Tighter yields show optimism, while more comprehensive yields show fear. These yields show that investors appear to have concerns about the economy despite the stock market highs.

What is our take on this indicator and data?

We think this tool, with these seven indicators, is quite interesting. It is well-balanced and has a good mix of momentum, breadth, fear, and economic indicators.

Regarding its current reading, it makes a lot of sense.

The old saying is, "Bull Markets climb a wall of worry." This data indicates that kind of environment.

Finally, we would use these indicators much like our RSI indicator.

An extreme on either side can give much insight into the near term, but it is usually simply one more piece of data.

We appreciate Frank for showing us how to look at the whole picture!