Obviously, considering our current economic situation and the overal news about the pandemic, it is understandable that a lot of investors or analysts believe in another stock market crash in the short-term. I fully understand that, it happend in march this year, so why shouldn’t it happen again? Here is why:
There is an interesting survey from the Yale School of Management. Unfortunately the indicators they provide are not well-known and not commonly used. But in my opinion there is a very helpful and interesting one, the U.S. Crash Confidence Index.
How to interpret this chart? According to the Yale School of Management, the Crash Confidence Index shows “the percent of the population who attach little probability to a stock market crash in the next six months. The Crash Confidence Index is the percentage of respondents who think that the probability is strictly less than 10%.“
What does that mean? The Yale School of Management performs a survey about the market sentiment. The questions they ask is if a respondant thinks that the probability of a market crash in the next 6 months is less than 10%. Thereby they ask insitutional investors and retail investors in parallel. Thus, this survey provides an extreme value about the market sentiment, from both institutional investors and retail investors. It is somehow similar to the Fear and Greed index.
A low U.S. Crash Confidence Index implies that the majority of respondants do believe in a market crash. A high U.S. Crash Confidence Index implies that the majority of of those surveyed do not believe in a market crash. Thus, based on the current U.S. Crash Confidence Index in the range of 20 currently, most people believe in another market crash right now. The question is how to interpret this indicator in view of your own invesment decisions. Let’s take a look at the extreme values during the financial crisis:
- U.S. CCI February 2007 (institutional): 57
- U.S. CCI February 2007 (individual): 37
- U.S. CCI March 2009 (institutional): 18
- U.S. CCI March 2009 (individual): 15
And how about the extreme values during the last year:
- U.S. CCI December 2019 (institutional): 48
- U.S. CCI December 2019 (individual): 30
- U.S. CCI September 2020 (institutional): 24
- U.S. CCI September 2020 (individual): 15
Now let’s compare these values with the chart of the S&P 500.
Prior to the financial crisis the U.S. Crash Confidence Index was at a high in February 2007. The same happend prior to the market crash in 2020, the U.S. Crash Confidence Index was at a high in December 2019. Considering that, it seems that it is more likely that we experience a market crash when the majority of respondants do not expect it (U.S. Crash Confidence Index at high point).
In addition, in March 2009 the U.S. Crash Confidence Index was at a low, marking the bottom of the stock market crash of the financial crisis and the starting point of another bull market. Due to that, it seems that it is more likely that the markets will rise when the U.S. Crash Confidence Index is at a low point. Now in September 2020 the markets already have recovered, but the U.S. Crash Confidence Index is still at a low. Does that imply that we are at the beginning of another bull market?
The financial crisis is a very discriptive example of how to interpret this index and I also verified this with other market indexes besides the S&P 500 and also on smaller corrections. Based on that, usually the masses are not correct in predicting the future direction of the stock market. Besides the recovery of the markets during this year, there is still a lot of anxiety about another crash due to the pandemic, but the current sentiment and a low of the U.S. Crash Confidence Index supports my expectation, that another crash is unlikely in the short- to mid-term.
Interestingly, the U.S. Crash Confidence Index for institutional investors increased during the crash in March 2020 from 48 in December 2019 to a multi-year high of 51 , while it dropped for retail investors. My interpretation of that is, that based on their experience the majority of institutional investors did not expect the markets to further drop after a crash of 30-40% that just had happened.
What do you think about that? I think it is a very interessting coincidence that the U.S. Crash Confidence Index has marked a multi-year high twice just prior to a bigger market crash and has marked a low just prior to the recovery after the financial crisis. If you like this post, also check out My Outlook On The Stock Market.