When I attended CPR training many years back, the instructor told us that one of the very first things you should be doing when attending to someone who seems to be unconscious is to ask the person if he/she is okay and see if the person respond to you. That question itself serves as one of the indicators thus to know if the person requires any further help.
The current market situation prompts me to think the same. The market has not much upwards or downwards movement and is almost a flat line over the past week. And as you know, flat line is never good when you see it on a patient monitor.
Given this context, I'm left wondering if it's possible that we also have some indicators to help us understand if Mr Market is okay?
After some thoughts, here are a few possible indicators that I think could be of good use to understand Mr Market a bit better.
First, the CBOE Volatility Index (VIX). VIX is a real time market index that reflects the market expectation of 30-day forward looking volatility. There are various ways how VIX could be measured. It could be measured by making use of statistical information of the historical prices of the market over a period of time to derive a standard deviation measure which could then be used to imply volatility. Alternatively, it could also be measured by combining the weighted price of the put and call options for the index.
How is VIX being used to understand Mr Market then?
In most cases, Mr Market goes up when the VIX value goes down. Similarly, Mr Market goes down when the VIX value goes up. This is especially relevant over short time periods.
Usually, a VIX value above 30 isn't a good sign as it represents fear and uncertainty in the market. A good VIX value will be anything below 20 as it represents stability in the market. To put things into context, the VIX value was above 80 in March when the great drop happens. Its current value is ~31.
Second, the fear and greed index. It is an indicator created by CNN Money to understand the emotions (fear, greed) in the market. Excessive greed by the investors could drive Mr Market up while excessive fear by the investors could drive Mr Market down. This index is made up of seven different factors namely Stock Price Depth, Safe Haven Demand, Put and Call Options, Stock Price Strength, Junk Bond Demand, Market Momentum and Market Volatility (which is VIX that I highlighted earlier, hence this fear and greed index can be deemed as a more comprehensive indicator as it incorporates other factors too). Market Momentum is a factor which I used heavily in most of my trend investing methodologies.
Each of these seven factors provides an indication of the fear and greed of the market, and the index is an eventual equal weighted-average of each of them. I encourage you to click on the link here to understand more about these individual factors.
Advocates of this index have a strong argument that the market is primarily driven by people emotions. Greed and fear are some of the most powerful emotions we have and having clear understanding which is the dominant emotion at play in the market could allow us to better understand how Mr Market is doing. This is akin to sentiment analysis which I have briefly covered in a previous article. The main difference here though is that the sentiment analysis done here are based on several market technical indicators instead of words used in social media.
During the March lows, the index shows an indication of "Extreme Fear". Its current indication is "Neutral".
Third, Buffett indicator. What? You mean Warren Buffett has an indicator? Well, probably not officially. It was however understood that he finds the ratio of the total market cap of the stock market relative to the US GDP to be probably the best measure of valuations. With that ideology in mind, the Buffett indicator that people widely used is simply the ratio of the total market cap of the stock market relative to the US GDP.
Using this ratio, it is used to measure if Mr Market is overvalued or undervalued at any point of time. Over a long period of time, reversion to the mean is expected to happen. Hence, if the market is overvalued according to the Buffett's indicator, it is expected that you will be getting lower long term returns as Mr Market will return to its correct valuation levels. Similarly, if the market is undervalued according to the Buffett's indicator, it is expected that you will be getting higher long term returns.
Based on this ratio, several tiers are created to determine the valuation of the stock market. For instance, any ratio below 50% represents significantly undervalued while a ratio above 115% represents significantly overvalued.
Currently, this ratio stands at 148.3%. Well, I think you have a good idea what this means.
Last but not least, my own indicator. For those who have been reading my blog, you all might remember that I wrote an article on "A data science approach to trend investing". In that article, I highlighted how i used data science tools (such as random forest) to create a model which enable me to better made "Buy", "Sell" or "Hold" decisions. The model is trained with historical technical information such as (SMA 20, SMA 50 and SMA 200) on past S&P 500 closing prices to predict the likelihood of Mr Market's movement in the near term. Information used to train this model dates all the way back to 2008. I'm still actively using this model to better determine my trading decisions and its performance has been satisfactory to me. More detailed information on this is shared with my patrons (https://www.patreon.com/datascienceinvestor) on a regular basis.
Now you might be wondering what is the current indication like based on my model.
Here is what I am getting (30% Sell, 66% Hold, 4% Buy). As you can see, the buy signal is extremely weak with only 4% possibility of Mr Market being on the uptrend (a 10% increase in S&P 500 closing price in the next 50 trading sessions) in the near future. This is one of the weakest buy signal I have seen in the recent weeks.
So, what are all these indicators telling us now? Is Mr Market okay for now? Is he likely to recover strongly or is he more likely to grow weaker in the near future?
If you have followed through this article, I'm sure you already have an answer in mind.
Enrol Mr Market into that care program.
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