Stock Market Confidence Indexes May Foreshadow Market Crash

Wednesday, 13 Nov 2013 08:00 AM

By Michael Kling

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Confidence indexes may point to a coming stock market crash, some analysts fear.

For instance, the Yale Crash Confidence Index for individual investors was 34.63 in September, which means nearly 35 percent of individual investors are confident that the stock market won't crash within six months. This index has mostly been below 30 percent since 2007.

The Yale Crash Confidence Index is a contrarian indicator, therefore, an increase in optimism points to a market downturn.

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Some analysts note that the last time this confidence index was this high was before the dot-com collapse in 2000 and the global financial crisis in 2007. However, the index doesn't necessarily predict crashes. For instance, it was even higher, at 48.8, in October 2003, but did not predate a downturn.

Typically, mom-and-pop investors jump into the market late — after it has boomed and is approaching its peak. Experts point to the rush of small investors into high-tech stocks just before the dot-com crash in 2000 and their strong interest in stocks just before the financial crisis.

Joseph P. Kennedy, father of President Kennedy and the fist Securities and Exchange Commission chairman, claimed he got out of stocks before the 1929 crash and preserved his fortune because a shoeshine boy was giving him stock tips.

Citigroup's Panic/Euphoria model also points to possible trouble. It reached its highest level in almost five years, coming close to the euphoria zone.

"The Panic/Euphoria Model is sending a clear warning sign of substantial complacency," Citi's Tobias Levkovich wrote in a note to clients, according to Business Insider.

"The investment community's mindset is widely monitored and investors anecdotally have become more bullish in conversations and meetings looking to an expected traditional late-year seasonal rally, despite a better than 20 percent move year-to-date."

In addition, according to the latest American Association of Individual Investors' sentiment survey, 45.5 percent of individual investors are bullish on stocks, up from the long-term average of 39 percent, and just 21.8 percent were bearish on stocks, compared with the longer-term average of 30.5 percent.

"Investor positioning is pretty aggressive," Daniel Needham, chief investment officer at Morningstar, told CNBC. "I wouldn't be surprised to see asset prices fall."

Still, predicting crashes is a difficult endeavor, and the sentiment of individual investors may not be an accurate contrarian indicator, he said.

"The individual investors are jumping in is as much a reflection of stocks going up," he told CNBC. "When markets are up, people become optimistic and put more money into markets. It's normal investor behavior. To say jumping into the market heralds a crash is pretty extreme."

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Related Stories:

BofA Sentiment Indicator Says Stocks Are a Buy

MarketWatch's Spano: Small Investors Will Take a 'Shellacking'

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