C.J. Lawrence Weekly – The Bears are Back. Contrarians Take Note.

Despite a strong close to last week, the S&P 500 Index finished in negative territory for the first quarter of 2018. The Index is down 1.2% year-to-date. Interestingly, the headline-challenged Technology sector index continues to lead the performance pack among the major sectors, followed by Consumer Discretionary. They are the only sectors with positive year-to-date price performance, gaining 3.2% and 2.8% respectively. At the broader index level, 2018 had started on a strong note, with most major equity indices posting positive returns in January. Then, in February, the market’s psychology turned. In just the past two months, the S&P 500 experienced two 6+% corrections, and the CBOE Volatility Index (VIX) surged. In 2017, the VIX, which has an average reading of 17 since 2010, hovered close to a record low reading of 10 for most of the year. In fact, during 2017, the VIX closed above 15 only eight times. But since February 1, volatility has returned in spades, and it looks like it is here to stay. In the past two months the VIX has surged, and has closed below 15 only twice.

The recent increase in volatility, and concurrent swift and dramatic market corrections, have altered market psychology and have increased investor sensitivity to headlines and changes in momentum. The erosion in market sentiment is playing out in mutual fund and exchange traded fund flows, where equity flows have turned negative, according to data from the Investment Company Institute. Coming into the year, expectations were high that investors would reverse a multi-year trend of flows out of equity funds and into bond funds. That looked to be the case early in 2018, but increased volatility may have contributed to a “return to safety” and sent buyers back into the arms of bond fund managers. Since February 1, domestic stock mutual funds and exchange traded funds have experienced $52 billion of outflows while bond mutual funds and exchange traded funds have experienced $20 billion of net inflows.

The equity fund outflows correspond with a meaningful shift in market sentiment, as reflected by the American Association of Individual Investors (AAII) weekly survey. The most recent results show bearish sentiment at its highest level in seven months. In fact, the pessimism measure has climbed by a cumulative 14 percentage points over the last two weeks. Bullish sentiment, meanwhile, declined to 31.9% in the most recent survey, staying well below its historical average of 38.5%. The institutional community is reflecting similar negative posturing as reflected in put-call spreads. Indeed, demand for put-options has surged over the past two weeks. The 10-day put/call ratio has moved from a multi-year low in January to its highest level since the 2016 elections. The message in these signals is that the bears are back, and that individual and institutional investors are re-positioning portfolios for a bumpier ride. Contrarians will take note of this development, and will find the shortage of bulls constructive.

Full Disclosure: Nothing on this site should be considered advice, research or an invitation to buy or sell securities, refer to terms and conditions page for a full disclaimer.

Terms and Conditions


Related Posts