I believe an effective indicator of market sentiment could help investors avoid subpar performance at market extremes. A number of sentiment indicators already exist such as the put/call ratio, the CBOE Volatility Index (VIX), as well as various surveys that attempt to take the “investment pulse” of individual and institutional investors.
Each of these indicators has its shortcomings, most often the omission of one or more important factors that may influence market sentiment. With the goal of synthesizing a single indicator, my firm recently created, the Acertus Market Sentiment Index (AMSI).
AMSI consists of the following five variables, in descending level of importance: Price/Earnings Ratio (a measure of stock market value), Price Momentum (a measure of market psychology), Realized Volatility (a measure of recent historical risk), High-Yield Return (a measure of credit risk), and the TED Spread (a measure of systemic financial risk).
The AMSI values range from 0 (extreme fear) to 100 (extreme greed). The indicator views sentiment as a continuum with anxiety and complacency representing less extreme and nuanced forms of fear and greed, respectively. Generally, a lower reading (< 20) of the indicator reflects a market sentiment of anxiety or fear. Conversely, a higher reading (>80) of the indicators suggests significant complacency or greed.
The current AMSI reading of 66, when taking into account the interaction of its component parts, indicates growing market complacency, which is indicative of generally increasing market risk. That AMSI score was driven primarily by high readings for momentum and low readings for volatility and the TED Spread - all three of which signal a growing level of complacency.
However, these three readings are offset somewhat by the relatively low current level of P/E which, on its face, is an indicator of low complacency. The current S&P 500 P/E value of 17.44 places it in the 47th percentile since the AMSI’s 1986 data inception point, a period during which the historically high levels of P/E during internet bubble skewed its behavior. However, if we analyze P/E data going back to the mid 1950s when its statistics became available, the current P/E value of 17.44 would rank near the 61st percentile. When we view P/E in its longer historical context, its current level falls into a more normalized range, leading us to posit that the current AMSI reading indicates an even higher level of complacency accompanied by increasing risk.
Given this heightened and growing sense of complacency in the market, I favor investments with downside protection at this particular point in time. Bonds are no longer the safe haven they have been for the past three decades, so I think investors need to look off the beaten path. Three of my favorite recommendations at this time are Mainstay Marketfield Fund (MFLDX) and FPA Crescent Fund (FPACX). Marketfield uses a long/short approach, similar to a hedge fund, with the advantage of being in a mutual fund format. FPA is willing to hold a large allocation to cash on an opportunistic basis.
