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Sound Advice: May 11, 2022

Taking the Pulse of the Market 

Although investors are regularly bombarded by claims that movements of individual stocks as well as those of the market overall are predictable, those pitches are on a par with the Wizard of Oz and the Tooth Fairy.  It is reasonable to believe that over extended periods of time changes in the prices of individual stocks and the investment market as a whole reflect changes in underlying profitability.  It is, however, not reasonable to think that forecasts of what will take place in relatively short periods of time have any merit.

With that said, however, there are some indicators that may be helpful in pointing toward what lies ahead.  Two of the more useful ones are the Goldman Sachs U.S. Equity Sentiment Indicator and the CBOE Volatility Index, a.k.a., the VIX or Fear Index.

The last 14 times the Goldman Sachs indicator hit the extreme low levels that we’re seeing now, returns from stocks in the time that followed were positive 100% of the time, with a median return of 19%.

The VIX is a contrarian indicator that’s also worth watching.  It’s a technical measure that tracks supply and demand for index options.  It measures the changes in how more sophisticated investors are viewing market valuations.

During periods when markets are relatively calm, that indicator generally moves within a range of 10 and 20 on a scale of 0 to 100.  Toward the bottom end, it suggests that investors are quite comfortable with their perception of the market’s future path.  As it moves higher, concern creeps in.  When the VIX climbs above 30, the pace of market turmoil tends to increase as investors become unsettled. 

Readings tend to rise to 30, 40, and higher during high stress periods.  The most recent example of this was on March 16, 2020, the beginning of the pandemic, when the index soared to 65.54.  It went even higher, to 79.13, on October 20, 2008, during the financial crisis of 2008-9.  In both cases, as is typical when the VIX climbs sharply, stocks were much higher a year later.

That indicator has bounced above 30 several times this year, as investors digest the economic and geopolitical problems that have arisen.  Although this high level may persist for a while, as pressure eases, the prices of stocks will recover.

N. Russell Wayne, CFP®

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