Panic/Euphoria Model is Nearing Euphoria as Investors Follow the Trend
We actively monitor dozens of investor sentiment gauges.
One of the sentiment indicators we monitor is the Citigroup Panic/Euphoria Model, and when it reaches an extreme, I share it here.
According to Citi, the panic/euphoria model is a gauge of investor sentiment. It identifies "Panic" and "Euphoria" levels which are statistically driven buy and sell signals for the broader market.
Historically, a reading below panic supports a better than 95% likelihood that stock prices will be higher one year later, while euphoria levels generate a better than 80% probability of stock prices being lower one year later.
Currently a level at or above 0.41 indicates euphoria and anything at or below -0.17 indicates panic, so with the current level of 0.32 and rising suggests the market is nearing an overly bullish, complacent, stage.
Nothing drives investor sentiment like a directional price trend with momentum, and over the last few months we've seen the stock indices enter an uptrend with some velocity.
In the lower panes, we show the S&P 500 index is 1.6% above its 50 day average and 9.3% above its of the past 200 days.
As the price trend has trended up, the realized volatility as measured by the percent of its average true range over the last 15 days has declined.
Rising price trends with falling volatility are good for trend following systems until it's reached an extreme, then a countertrend becomes more likely, and that's about when investors are the most bullish as they extrapolate the recent past into the future.
Investors get most bullish after prices have already trended up, and with less volatility to shake them out.
When prices spread out far and wide, aka "volatility", those large up and down days keep the market on edge, but when prices tighten up and most of the daily price action is on the upside, it makes the market feel more confident.
With confidence eventually comes complacency, and that's when any hint of bearish news may cause the market to trend in the other direction at least temporarily.
Just as under-reaction to new information drives price trends as it drifts directionally, when investors are complacent and expecting a continuation of trend, any surprise can result in an over-reaction.
A simple idealized example of how we can measure over-reactions is the relative strength index over the past 15 days, which I've added in the lower pane of the chart.
The relative strength of the S&P reached a short term extreme twice since June, and this time it has turned down to the 50 level, which I think of as the center field position, the 50 yard line of a football field.
When offense and defense are lined up in center field, both have an equal opportunity to take the ball and run with it. As you can see, the SPX paused at the 50 this week, so I'll be watching to see if it holds or continues into a deeper downtrend.
There's not shortage of bearish headwinds for the rest of the year from cycle analysis like the 4 year Presidential cycle among other things, and the stock market got short term overbought and vol was declining.
I shared on X (formerly Twitter) last week:
Then, the 30-year yields rose 14bp and the yield curve steepened by a similar magnitude. It’s the third consecutive day of bearish steepening.
On top of the Panic/Euphoria Model showing a trend toward euphoria, some of the last stock market bears on Wall Street capitulated recently, including Morgan Stanley and JP Morgan.
I think their timing is wrong, but we'll keep messin' around, and finding out.
Volatility contractions are eventually followed by volatility expansions.
In the short term, the asymmetric risk/reward favors more downside.
Mike Shell is the founder, President, and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of Asymmetry® Managed Portfolios. Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies. Shell Capital provides investment advice and portfolio management to clients with separate accounts at Goldman Sachs Advisor Solutions with an investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not individualized advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. If this website contains information regarding Options Trading, please read the Characteristics & Risks of Standardized Options, also known as the options disclosure document (ODD). Options involve risk and are not suitable for all investors. The views and opinions expressed in Asymmetry® Observations and Asymmetric Investment Returns are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.