Gauge of Investor Fear Signals Market Drop: U.S. Stocks Outlook
Aug. 3 (Bloomberg) -- Investors have little fear of a swing in U.S. stock prices, according to an indicator that can signal market turnarounds. To some investors, the gauge suggests that this year's rally has gone too far.
The Chicago Board Options Exchange's OEX Volatility Index, known as the VIX, closed as low as 19.93 last week. The reading was the lowest in 16 months for the index, based on the prices of stock-index options.
During the previous three years, the index dropped below 20 only twice, in August 2000 and March 2002. Both moves marked the start of a months-long slide in stocks.
The VIX has slumped this year as the Standard & Poor's 500 Index has advanced 22 percent from its low on March 11. The drop is evidence that many investors are done buying stocks for now, said A.C. Moore, chief investment strategist at Dunvegan Associates Inc. in Santa Barbara, California.
``We're starting to see a buildup of complacency,'' said Moore, whose firm manages $500 million. ``Everybody's looking at the glass as half full.'' He has sold some computer-related stocks and let cash build up in some clients' accounts.
Indicators such as the VIX may get more attention from investors because the flow of second-quarter profit reports is tailing off. Thirty-five companies in the S&P 500 will announce earnings this week, down from 86 last week. Cisco Systems Inc., Gillette Co., U.S. Steel Corp., Prudential Financial Inc. and Winn-Dixie Stores Inc. are among those on the calendar.
Sell Signal
The VIX measures the expected future volatility of U.S. stocks from the prices paid for option contracts on the Standard & Poor's 100 Index. The index, whose symbol is OEX, consists of 100 of the largest companies in the S&P 500. Eight options to buy or sell the S&P 100 go into the calculation.
Higher stock prices tend to result in lower volatility, showing a lack of fear among investors. ``Usually that precedes a move down,'' said Jack Bouroudjian, an independent trader at the Chicago Mercantile Exchange.
The S&P 500 dropped 1.9 percent last week as the VIX reached its low and then rose for four straight days. The volatility index ended the week at 22.78, just above its 21.77 reading when the S&P 500 reached its high for the year on June 17.
Technical analysts, who predict stock moves based on price patterns and market statistics, view the measure as a contrarian indicator. A low reading may mean investors are already committed to stocks and aren't worried that prices will fall.
Survey Readings
The index dropped below 20 on Aug. 18, 2000, and stayed there through Sept. 1, the same day that a six-month rally ended for the S&P 500. The stock-market benchmark fell 13 percent for the rest of the year.
In the last two weeks of March 2002, the VIX also slid below 20. The S&P 500 lost a quarter of its value through year-end after rising 8 percent from Feb. 7 through March 19, two days before the first sub-20 reading.
This year's decline in the indicator follows a plunge in pessimism in market survey. Investors Intelligence's weekly poll of investment-newsletter writers, for instance, showed bearishness on stocks tumbled during the week ended June 13 to 16.1 percent. The reading was the lowest since the week ended April 3, 1987.
Bullishness or complacency alone doesn't signal the end of a rally, said analysts such as Philip Roth, a technical analyst at Miller Tabak & Co.
``It's one indicator of 150 I follow,'' Roth said of the VIX. There are three elements of any market peak -- excessive optimism, selling by insiders and a decline in prices after a rally --- and the last hasn't taken place yet, he said. The S&P 500 has slipped just 3.1 percent from its June 17 high.
`Better Times Ahead'
Investors such as Robert Baur, who oversees $16 billion in equities at Principal Global Investors in Des Moines, Iowa, said both the rise in share prices and the drop in expected volatility are justified.
``We think the stock market is reflecting the economy -- and the economy has much better times ahead of it,'' Baur said, adding that stocks will climb even with the VIX below 20.
The economy grew at a 2.4 percent annual rate in the second quarter, the government reported last week. Economists expected a 1.5 percent pace, according to the average estimate in a Bloomberg survey. Manufacturing expanded last month for the first time since February, according to the Institute for Supply Management.
Analysts are raising estimates for corporate profit growth. Earnings for S&P 500 companies probably will grow 14 percent this quarter and 22 percent next quarter, based on the average analyst estimates compiled by Thomson Financial. When the second quarter ended, the averages were 13 percent and 21 percent, respectively.
For some money managers, the optimism has gone too far because the rally in stocks already reflects the potential for profit growth. Cisco, for example, has surged 46 percent this year and rose last week to its highest price in 18 months. The company reports earnings after the market closes Tuesday,
Investors may want to move out of stocks, ``where there's complacency, and into areas where there's anxiety,'' said Anthony Hitschler, Brandywine Asset Management's chief investment officer. The Wilmington, Delaware-based firm oversees $8.5 billion.
Last Updated: August 3, 2003 09:45 EDT |
