Fear Index Says This Stock Market Reminiscent of October 2007


By Michael Lombardi, MBA for Profit Confidential

The euphoria among stock advisors and investors alike seems to be increasing as key stock indices proceed to move into uncharted territories. I see it all as a bearish indicator. Just look at the chart below of the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), often referred to as the “fear index:”
The VIX is fairly close to where it was in 2007, just before one of the worst market sell-offs in history hit the key stock indices. Since the beginning of this year alone, the fear index has fallen almost 30%. This index is screaming that investors are too bullish towards the key stock indices!
As Warren Buffett once said, “Be fearful when others are greedy, and be greedy when others are fearful.” (Source: Buffett, W.E., “Buy America. I Am.,” New York Times, October 16, 2008, last accessed March 13, 2013.) And the VIX is saying investors are far too complacent about stock prices today.

$VIX Volatility index new methodology stock chart

Chart courtesy of www.StockCharts.com

The reality of the situation is that there is a significant disconnect between the stock market and the economy—they are moving in opposite directions. Unemployment, consumer spending, and the housing market are still under major stress.
In addition, companies listed on the key stock indices are under profit pressure. According to FactSet, companies in the S&P 500 are expected to show negative earnings growth in the first quarter of 2013—the second time this has happened in three quarters. The expected growth rate is -0.6%. Just this December, the earnings growth rate for these companies was estimated at 2.2%. (Source: FactSet, March 8, 2013.)
Furthermore, of the 107 companies in the S&P 500 that have provided outlooks for their corporate earnings, 77% of them have issued a negative outlook. The percentage of S&P 500 companies issuing negative outlook is much higher than the five-year average of 61%.
Dear reader, to me, it seems we are seeing history repeat itself. Back in 2007, stock advisors were expecting key stock indices like the Dow Jones Industrial Average to reach 20,000—instead, it took a turn and dropped by more than 50%. Now, the predictions are much higher, with one stock advisor calling for the Dow Jones Industrial Average to go up to 36,000!
Key stock indices might continue to run a little bit higher—that’s exactly what bear traps do; they lure investors in and then leave them in misery.
Add corporate insiders selling stock at a record pace and companies buying back their own shares to prop up earnings to today’s bullishness, and it makes me even more skeptical about the rise in the key stock indices. The stock market can stay irrational for now, but I continue to hold a bearish view on the market and practice caution.
Michael’s Personal Notes:
In the last three months of 2012, the United Kingdom (U.K.) experienced a contraction in its gross domestic product (GDP). Another contraction in the current quarter will put the U.K. into another recession. (Source: Reuters, March 12, 2013.) So far this quarter, the economic numbers don’t look good for the U.K., as manufacturing fell 1.5% in January.
Of course, many eurozone members are deep in recession. Jens Weidmann, President of Germany’s central bank, the Bundesbank, said this week, “The crisis is not over despite the recent calm on the financial markets.” (Source: Kuehnen, E. and Carrel, P., “Euro woes not over, German central bank says, as piles up crisis fund,” Reuters, March 12, 2013.) First it was the debt-infested nations that caused economic chaos; now stronger nations, like France, are struggling to keep up as they face high unemployment rates.
The situation elsewhere in the global economy is deteriorating quickly, and it’s not just the U.S., U.K., eurozone, Japanese, and Chinese economies that are suffering. According to JPMorgan Global Manufacturing and Services Purchasing Managers’ Index (PMI), the global economy’s output dropped to its lowest level in four months in February 2013, reaching 53.0, compared to 53.2 in January. (Source: Markit, March 5, 2013.) Any reading below 50 marks contraction.
Demand drives economic growth. If there is bleak demand in the global economy, a recession becomes a very likely scenario. The major economic hubs in the global economy are suffering through an extensive recession or are seeing their economies slow. It’s not very convincing, to me, to believe there is any economic growth in the global economy.
If the global economy does fall back into recession, and there is a big possibility it could, it will have a major impact on the U.S. economy, especially on American-based multinational corporations. When countries in the global economy see a decrease in exports and imports, the companies that sell and manufacture goods come under scrutiny, as their profits decline.
Major U.S. companies, like those on the S&P 500, are already displaying negative profit growth—which will lead to more uncertainty. And I doubt excessive money printing will help these companies this time around.
What He Said:
“When I look around today, I see falling stock prices…I see falling house prices…and prices for retail goods stores declining. The media has it all wrong blaming (worrying about) inflation. In my opinion, the single biggest threat to the U.S. economy and to the Fed in 2008 is deflation. You can bet the Fed will expand the money supply and drop interest rates aggressively as deflation starts to rear its ugly head.” Michael Lombardi in Profit Confidential, December 17, 2007. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.


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