4 Signs Stocks Are Climbing a 'Wall of Worry'

The latest data suggests we haven't hit the 'euphoria' phase of the sentiment cycle that marks stock market tops

by Andrea Kramer

Published on Jul 13, 2017 at 2:11 PM

Even though the stock market's "fear gauge" -- the CBOE Volatility Index (VIX) -- is on pace for its lowest daily average ever in 2017, expectations for a volatility pop are approaching fever pitch, per recent VIX options activity. Echoing that, despite stocks' recently renewed quest for record highs, additional data suggests Wall Street remains wary. Below, we'll discuss the latest evidence of growing skepticism, including a major exodus of cash from domestic stock funds and a revived appetite for short positions both in and out of the options pits.

U.S. Outflows Ramp Up

"The familiar pattern of U.S. equity outflows and international equity inflows showed up again" in early July, per ETF.com. Specifically, U.S. equity outflows totaled $1.7 billion in the week ended July 6, while foreign equity inflows hit $3.2 billion.

Echoing that, the latest data from BofA-Merrill Lynch indicates that tech funds saw their biggest outflows in 30 weeks, while emerging markets enjoyed a 23rd straight week of inflows. Investment Company Institute, meanwhile, said investors withdrew $11.6 billion from U.S. stock funds -- the largest since April -- pushing exchange-traded fund (ETF) and mutual fund flows negative for the first time since January. (In related news, investors reportedly withdrew $400 million from David Einhorn's Greenlight Capital fund, which fared relatively poorly in the first half of the year, no thanks to a short position on stock-market superstar Tesla.)

Sentiment Surveys

The National Association of Active Investment Managers (NAAIM) survey showed a second weekly decline in equity exposure last week. The index dropped to 89.90, marking just the second reading below 90 in 10 weeks.

Likewise, the number of self-identified bulls in the American Association of Investors Intelligence (AAII) survey fell to 28.2% last week. AAII bulls have been under 50% for 132 weeks, according to Schaeffer's Quantitative Analyst Chris Prybal, marking the longest streak on record. Meanwhile, the number of self-identified "neutral" investors rose to 42.1% last week. The 10-week average of AAII neutral sentiment is now 39.5% -- the highest since just before the November election.

Short Sellers Diving Back In

After touching a multi-year low earlier this year, short interest on S&P 500 Index (SPX) stocks has been creeping higher. In the latest reporting period, short interest on S&P equities rose 1.88%, and now sits at a year-to-date high. Looking back five years, SPX short interest has been higher just over 26% of the time, per Prybal.

SPX short interest


In the same vein, short interest on Russell 2000 Index (RUT) stocks is flirting with annual highs, after bottoming in early 2017. Short interest has jumped more than 10% year-to-date on small-cap stocks, and has been higher just over 21% in the past five years.

RUT short interest

Put Options Popping Again

Finally, options traders have been ramping up their exposure to long puts over calls. The 10-day average of the equity-only buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) has risen to 0.62 -- its loftiest level since May 1, according to Prybal. In other words, options buyers have shown a healthier-than-usual appetite for bearish bets over bullish of late.

10day equity pc ratio


The chart below shows the 20 stocks with the most total options volume over the past 10 trading days, courtesy of Schaeffer's Senior Quantitative Analyst Rocky White. Apple stock generated the highest put volume on an absolute basis, with more than 915,000 contracts exchanged. However, just AT&T and fellow Dow stock Nike saw absolute put volume exceed call volume in this time frame. Twitter stock -- highlighted below -- is new to the list since the last time the data was run a few days ago.

mao chart july 13

Climbing a 'Wall of Worry'

In conclusion, it still seems we haven't yet hit the "euphoria" phase of the sentiment cycle that marks market tops. Whether that's because of political uncertainty, expectations for the Fed, or pessimism ahead of the next round of corporate earnings is anyone's guess. However, contrarians can find comfort in the old adage "markets advance on a wall of worry and decline on a slope of hope."
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