The American investor begins the year with a more optimistic outlook and a greater inclination to take risks, at least based on the indicators tracking market participants’ “fear.”
However, the indices measuring this sentiment should not be used in isolation when deciding to increase portfolio risk.
The primary indicator is the VIX (volatility index). Calculated by the Chicago Board Options Exchange, it considers the performance of S&P 500 stocks over the last 30 days.
A high index indicates greater volatility, earning it the nickname “fear index.”
The higher the index, the more intense and rapid the fluctuations in S&P 500 stocks—and the greater the “fear.”
Currently, the VIX stands at 13.65 points, a 40% drop in 12 months—far from the 66 points reached in March 2020 at the onset of the Covid-19 pandemic or the 79 points during the 2018 global financial crisis.
Eduardo Rahal, Chief Analyst at Levante, notes that the VIX can be used as one tool in decision-making but should always complement a broader analysis of a particular asset.
This broader analysis is necessary because a very low index is not necessarily positive; it could indicate that gains are nearing their peak.
“To illustrate, after all other analyses, an investor may, for example, identify an opportunity in the market when the VIX is excessively high, indicating significant fear and high volatility.
The reverse is also true; the investor may perceive a very low VIX as an indication of a market peak,” he says.
Optimism among individual investors But the VIX is not the only indicator showing increased investor optimism.
A survey by the American Association of Individual Investors (AAII) reveals an extremely optimistic sentiment, and this mood shift occurred in a short time span.
On December 21, the AAII market sentiment index showed that investors had the highest level of optimism in the last two and a half years.
In this index, investors indicate how they believe stocks will perform in the next six months. A significant portion, 52.9%, bet on an increase—the highest level since April’s 53.8%.
There was a slight dip in the latest survey conducted a week later. Nevertheless, the optimistic segment was still at 46.3%, above the historical average of 37.5%.
Investors also expressed greater optimism about their year-end results. According to the survey, 46.9% believe their portfolios will perform better than expected, and 19.6% expect “much better” performance.
The “Fear and Greed” index from CNN Business also aligns with this trend. It tends to indicate, based on various indicators, including the VIX itself, whether the market is pessimistic or “greedy.”
For the past two weeks, this index has signaled that the market is “extremely greedy.” A year ago, the sentiment was one of fear.
This optimism among investors has a reason—the improvement in macroeconomic data in the United States, such as better control of inflation and the signal that the Federal Reserve (the U.S. central bank) will begin cutting interest rates in 2024.
“This could prove to be a tailwind for U.S. stocks, especially for smaller-cap companies that tend to perform well when inflation and inflationary cycles peak and begin to decline,” said Jo Groves, investment analyst at Kepler Partners, in a report.
In theory, an indication of greater optimism may suggest more investors inclined to buy, and thus, prices are likely to rise. However, as in all markets, it’s challenging to pinpoint the exact moment when this sentiment peaked.
“The relationship between the VIX and the decision to allocate to stocks is more complex than that.
While changes in the VIX can provide useful information about market sentiment and volatility expectations, they should not be used in isolation to make stock allocation decisions,” emphasizes Rahal of Levante.