Broadening Fear Means Increasing Potential For V-Shape Market Recovery

A widening fear level across many sentiment measures increases the likelihood of a strong market bounce. I will not rehash the panic narrative I wrote about last weekend, but sentiment measures are becoming increasingly bearish.

• NAAIM Exposure Index: The NAAIM Exposure Index was reported at 29.03% this week, a 36 percentage point decline from the week earlier. The NAAIM Exposure Index consists of a weekly survey of NAAIM member firms who are active money managers and provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesday. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers as a group. Institutional money managers have equity allocations at a level lower than the December 2018 market decline and near levels reached in the weak market of 2015/2016.

• VIX/10-Year Treasury Ratio:  Combining the VIX with the 10-year U.S. Treasury Yield incorporates the fear measure (VIX) with that of a recessionary measure, i.e., the 10-Year U.S. Treasury. This ratio is at 34.98 and above many of the levels where historically the market has turned higher. In fact the ratio remains at levels higher than reached during the financial crisis in 2008/2009.

• CNN Business Fear & Greed Index: The Fear & Greed Index continues to move lower and is reported at an extreme fear of 9 at the end of Thursday. The Fear & Greed Index incorporates seven indicators to arrive at an sentiment index reading. Indicators included in the calculation are: put call option data, junk bond demand, market volatility (VIX), stock market strength, i.e., the number of stocks hitting 52-week highs, stock market breath and safe haven demand, i.e., bond versus stock performance.

• AAII Sentiment Survey: Surprisingly one indicator not showing an elevated level of fear is the AAII Bullish Sentiment reading reported Thursday morning. The bullish reading was reported at 38.7% and up from 30.4% in the prior week.

As a number of the above charts show, when sentiment gets this washed out, V-shaped market recoveries tend to be a common occurrence. Clearly though, the current situation surrounding the coronavirus is instilling a level of fear that is not easily predictable in the short term. Individuals exhibiting this level of fear/panic can result in a self fulfilling prophecy in terms of forcing the economy into recession. Importantly, and Ryan Detrick, a Senior Stategist at LPL Research, notes, "Chinese stocks making a 2-year high today (3/5) is probably something that could win you a lot of bets this weekend. Odds are virtually no one in the US realizes this is happening." Why is this an important observation? Because the coronavirus outbreak seemed to have started in China and China is now getting back to a more normal level of activity. In other words, the world is not coming to an end and this to shall pass.