VIX Is Low But Investors In Denial Stage Of Market Sentiment Cycle

Many of the market statistics that measure investor sentiment suggests investors have become too complacent regarding this bull market. Strategist view this complacency as a contrarian indicator which raises a cautionary flag regarding further advances in the equity market. With the VIX Index trading at a record low level under 11, this index does indicate there is a low level of fear in the market. More detail on the VIX can be reviewed at one of our earlier posts, What Is The VIX Index.

From The Blog of HORAN Capital Advisors

Importantly for investors is the fact the VIX Index can trade at low levels for a multi-year time period as the above chart shows occurred from 2005 to early 2007.

Another sentiment measure that attempts to incorporate anticipated economic activity is to divide the VIX level by the 10-year treasury yield. We discussed this in a November 2011 post, Fearful Investors. A low level in the 10-year treasury yield indicates bond investors generally have an anemic growth and inflation outlook over the longer term. Looking at this indicator it to has reached a current low level of 4.05. However, as with the VIX, this indicator can trade at a low, if not lower level for an extended time period as well, 2005 - 2007.

From The Blog of HORAN Capital Advisors

So what does this all mean for investors. At HORAN we certainly do believe, or maybe better stated, "feel" as though a correction would be good for this market. We do believe if a correction occurs it will be a short lived one absent an unanticipated shock to the market. Inflation, CPI, was reported at a higher than expected level on Tuesday. If inflation continues to surprise to the upside, it will likely be driven by higher commodity prices and higher wage rates. This would generally occur with an economy that is strengthening. The result would be higher earnings growth for companies, which is needed based on Q1 earnings. The higher growth rate would likely lead to higher stock prices as well. To be certain though, the market does not move higher in a straight line. Our belief though is the market is at a greater risk of moving higher through year end than moving into a sustained downtrend.

Lastly, we do look at these sentiment readings in the context of the overall sentiment cycle. In a July 2009 post, Where Are We In The Market Cycle?, we included the below chart.

From The Blog of HORAN Capital Advisors

The above sentiment cycle chart was first published in 1991 by technical analyst Justin Mamis in a book titled, The Nature of Risk. We believe we are most likely in the "denial" phase of the sentiment cycle. We do not believe full confidence or enthusiasm has returned to this market. This week's Investor Sentiment Survey reported by the American Association of Individual Investors saw bullish sentiment fall 9.5 percentage points to 35.2%. The less volatile 8-period moving average is 34.7% and is not an overly bullish reading as can be seen in the below chart.

From The Blog of HORAN Capital Advisors

Given the amount of chatter about the need for a correction, a capitulation type buying frenzy seems not to have occurred yet.