Several major stock markets continue to power ahead notwithstanding Britain’s vote to leave the European Union and numerous unsettling events including the terrorist attack in Nice and the unrest in Turkey.
That could be a sign of investors getting complacent, typically a harbinger of market declines.
In fact, the volatility index of S&P500 (VIX) briefly rose above 25 after the Brexit vote and has quickly descended since then. It touched a low of 12.14 last Thursday.
In most cases, a high VIX reflects increased investor fear and a low VIX implies complacency.
Over the past two years, whenever the VIX dropped to around 12, it usually coincided with short-term peaking out of US stocks.
A market pullback is not always triggered by a specific event. Investors being too sanguine and excessive share price gains are enough to induce a downward adjustment.
The Chicago Board Options Exchange’s put call ratio is another handy gauge. Last week, this ratio also dropped to an extremely low level, reflecting overwhelmingly bullish investor sentiment.
Hence, it’s about time we revisited the age-old wisdom: nothing goes up forever.
This article appeared in the Hong Kong Economic Journal on July 20.
Translation by Raymond Tsoi
[Chinese version 中文版]
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