Complacency Concerns

With just one week to go before month’s end, the bulls are in full flight, with the major stock indices showing gains ranging from 4% for Europe, 5% for the US and Japan plus a heady 6% for the UK, all in just 17 January trading days.

Bullish sentiment is high, as evidenced by comments such as the following:-

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Risk appetite among fund managers has hit its highest level in nine years and is hovering near all-time highs, in a sign that the bulls have returned to equity markets after years in hiding.

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22 January 2013, by Rich Miller and Simon Kennedy

International investors are the most bullish on stocks in at least 3 1/2 years, with close to two-thirds planning to raise their holdings of equities during the next six months, according to a Bloomberg survey.

Further bullishness shows up, courtesy of Mathew Boesler of Business Insider.com, who provided the following chart.
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$US22.2 billion flowed into long-only equity funds in the week ending 11th January, reports Boesler, marking the second-largest weekly inflow in history and the largest inflow since March 2000. Flows were biased towards North American funds followed by emerging markets.

Now, you may think me old fashioned, or possibly a party-pooper, but my natural contrarian antennae pops up whenever I see headlines and charts such as those above and just as they did, but with a very bearish slant, as we neared the end of a 55% rout for stocks in early 2009.
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The US VIX, or Volatility Index, is a good measure of fear, or lack thereof, in the S&P 500, or SPX, stock index of America’s finest.

It is constructed by measuring the amount of premium on a select group of put and call options. When options writers are more fearful, they charge a higher premium, which translates to high VIX readings. Low VIX readings are evidence of complacency.

Looking at the second chart, where the VIX has been inverted so as to more logically follow the SPX, one can note that when it is at a very low reading, it often signals a market top.

The current VIX reading is lower than any reading since 2007 and judged by its history it looks to be signalling a market top, not the start or continuation of a raging bull market, as suggested by the recent comment and fund flows.

Investor emotions become very strong towards the end of a long market trend and whilst there are no guarantees that moving against the herd is always correct, it usually raises the odds in your favour.

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