Chart Advisor: Where are Sentiment Indicators Pointing?

By David Keller. CMT

August 2024 Market Update: Sentiment Indicators Point to Extended Decline

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August 2024 Market Update: Sentiment Indicators Point to Extended Decline

The equity markets are experiencing a choppy August 2024, leaving investors uncertain about the future. Are we headed for further declines, or will we see a recovery from recent pullbacks? Today, we’re looking into three crucial market sentiment indicators, each suggesting potential weakness.

Setting the Stage: Understanding Market Sentiment

Market sentiment plays a pivotal role in determining the direction of equity markets. By analyzing various sentiment indicators, investors can gauge the collective mood and potential future movements. Let’s explore three key indicators that currently suggest caution.

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The VIX: A Classic Volatility Measure

Our first indicator is the VIX, which reflects market volatility derived from options markets. This week, the VIX spiked over 65, marking the third-highest reading since the Great Financial Crisis of 2009. To put it in perspective, the COVID low in 2020 saw the VIX in the mid-80s, but readings above 60 are rare and typically signal significant pullbacks.

• VIX Insights: A VIX above 15 implies a shift from bullish conditions to a slight pullback, while readings above 20 suggest a 5-10% corrective phase. The recent climb above 60 could signal a more substantial and prolonged market decline, indicating that investors should brace for potential turbulence ahead.

The AAII Survey: Individual Investor Sentiment

Next, we consider the AAII survey, a critical gauge of individual investor sentiment. This weekly survey measures opinions on whether respondents are bullish, bearish, or neutral about the market for the next six months. Historically, a bullish reading above 50% indicates euphoric optimism, often preceding a market pullback.

• AAII Survey Dynamics: About four weeks ago, bullish sentiment spiked above 50%, serving as a red flag for potential corrections. Currently, bullishness has dropped from 52% to 40%, while bearish sentiment has risen from 22% to 38%, suggesting a growing pessimism. This shift indicates that investors are becoming more cautious, hinting at a potentially tradable low. However, it’s essential to wait for signs of accumulation before making any decisive moves.

The NAAIM Exposure Index: Professional Insights

Finally, we turn to the NAAIM Exposure Index, which tracks sentiment among professional money managers. Unlike the AAII survey, this index gauges how aggressively professionals allocate to equities.

• NAAIM Exposure Trends: Just like an AAII bullish reading above 50% signals euphoria, NAAIM readings above 100% indicate excessive leverage and optimism among money managers. Five weeks ago, this index was just over 100%, suggesting extreme bullishness. Since early July, however, there’s been a noticeable shift, with money managers reducing their equity exposure from leveraged long positions to more neutral or slightly underweight stances. This pivot toward a defensive posture suggests professionals are preparing for further declines.

Conclusion: Cautious Optimism or Further Decline?

In summary, the three sentiment indicators we examined—the VIX, AAII Survey, and NAAIM Exposure Index — each suggest potential market weakness ahead. Elevated VIX readings, shifting sentiment among individual investors, and money managers lightening their equity positions all indicate a possible extended pullback. While these indicators provide valuable insights, it’s crucial to watch for signs of accumulation and a break above key levels to confirm any market recovery.

Check out our Community Board Discussions on the current market shift.

What market sentiment indicators do you follow and use? Do you rely on any of those discussed here, or are there others you consider essential? Share your thoughts in the comments below! Also, feel free to suggest any other technical indicators, market sentiment gauges, or behavioral or technical ideas you’d like me to explore in future posts.

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Originally posted 13th August 2024