The Sentiment Siren Sounding for the First Time in Nearly 2 Years

The NAAIM exposure index has dropped significantly in the past six weeks

Nov 15, 2017 at 1:23 PM
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Stock market exposure by active money managers has plummeted in recent weeks, as evidenced by the National Association of Active Investment Managers (NAAIM) survey. Specifically, last week's NAAIM index touched 56.16 -- the lowest since May 2016 -- and has fallen by 40% in the past six weeks. Against this backdrop, we decided to take a look at how the S&P 500 Index (SPX), as well as the CBOE Volatility Index (VIX) -- or the stock market's "fear gauge" -- tend to perform after these relatively rare sentiment signals. Do active money managers know something we don't?

First Signal in Nearly 2 Years

The last time we saw such a steep, quick plunge in the NAAIM exposure index was late 2015 into January 2016, according to Schaeffer's Quantitative Analyst Chris Prybal. As you can see on the chart below, that pullback in money managers' exposure coincided with a sharp pullback in the SPX, but preceded a slow-and-steady rally over the next nearly two years. This time around, the NAAIM exposure index plummet began even before the stock market's current pullback, as the SPX was still exploring record highs.

naaim sentiment and spx since 2015

SPX Tends to Outperform After Signals

Prior to the early 2016 signal, you'd have to go back to the fourth quarter of 2014 for a similar NAAIM index drop. Since 2007, there have been 15 signals. In the past, these signals have been bullish for the SPX in the short-to-intermediate term. The index has averaged a two-week gain of 1.5%, compared to an anytime average gain of just 0.3%, going back to 2007.

In the same vein, the SPX was 2.2% higher one month later, on average, compared to 0.6% anytime. The outperformance is most evident two months after a NAAIM signal, wherein the S&P was up 3.6%, on average -- more than three times its anytime average return -- and was higher 79% of the time.

However, looking four and six months after a signal, the S&P's average returns were smaller than usual, at 2% and 2.3%, respectively. Still, the broad-market barometer was in the black 79% of the time four months after a signal, compared to 71% anytime over the past 10 years. What's more, the long-term data was majorly impacted by the financial crisis, with the SPX sharply lower six months after the late 2007 and 2008 signals.

spx naaim vs anytime since 2010

VIX Could Retreat, If Past Is Prologue

As such, it's no surprise to see the VIX tends to suffer sharp declines in the short-to-intermediate term after a sentiment signal. The "fear gauge" was in the red, on average, at every marker but two, going out six months. One and two months after a signal, the VIX was down an average of 11.9% and 12.6%, respectively, and was positive just 29% and 14% of the time. That's compared to an average anytime gain across the board, looking at data over the past decade.

The main outlier is the four-month marker, where the volatility index was up 3%, on average, after a sharp drop in the NAAIM exposure index. Still, that's less than the VIX's average four-month return of 6.3%. And again, that data is heavily skewed by the financial crisis, as the VIX more than doubled four months after the July 2008 signal.

vix after naaim vs anytime since 2010

Still No Evidence of Euphoria

In conclusion, if history repeats, the recent S&P 500 Index pullback -- and the accompanying VIX spike -- could reverse soon. After the last signal in 2016, the SPX was up more than 13% three months later, and a similar rally would put the stock market deep into uncharted territory to start 2018. Further, the drop in active money managers' exposure indicates there's still plenty of skepticism to be found -- so we have still not reached the euphoria that often occurs at a market top.

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