Does the Fear and Greed Index Say to Buy or Beware?
The Fear & Greed Index fell to extreme fear Tuesday. Is it flashing a buy or beware for dip buyers?
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Extreme Fear. Investors are extremely fearful. At least, that’s what CNN's Fear & Greed Index is saying.
Many of you are contrarians and salivate when you see that bright red indicator. You probably think it's time to buy the dip. But, is it? Is it time to buy or beware?
The Seven Components Are, Generally, Fearful
Market Momentum is the first of the seven indicators used and it’s calculated as the difference between the S&P’s price and its 125-day average. When I built Fear & Greed, I used the 125-day average because 6 months of price data is a pretty good measure of the market's medium-term activity. As you can see, when that moving average is pointed upwards, dip buying tends to work.
Where it is less effective is when Fear & Greed is already trending downwards, setting a lower high when stocks set a higher high, like in that period between 2021-22 shown in the black box below. That’s what we’ve had since the election. Stocks have gone up, while Fear & Greed has decayed.
That tells me that dip buyers should be cautious.
Additionally, both measures of market breadth have continued to roll over. Some of that is rotation out of the Mag 7 and into safer stocks, but more of it is investors walking out the door with their money. Risk off. What will bring them back?
Options Spiked but Only Suggest Near-Term Fear
The 5-day Average Put/Call Ratio has spiked higher, but it's hard to know if this is it or if it is just getting going. Same with the VIX. Earlier today, it indicated fear when it jumped to over 21. By the end of the day, it remained elevated, but no longer fearful. Still, my qualitative reading is that it’s near-term fear, until we see higher readings.
Bonds Show a Flight to Safety
Treasuries have finally come to life over the last week, while stocks are 3% off their highs. This is actually the worst performance for stocks relative to bonds since last summer. At the same time, safer, investment grade bonds, are beating junk bonds. That indicates a flight to safety.
Where Does That Leave Us?
Let's take the weight of the evidence to see if dip buyers should buy or beware.
Market momentum is weakening, but the 125-day SMA of the S&P 500 is still upwards sloping and indicates that the bull is still intact. That's good!
However, Fear & Greed has shown a declining trend since the election. That's often a bearish signal. That's bad!
Breadth is weakening, too. That's bad!
Options traders are becoming a little less speculative, but they're not actively hedging ...yet. They're, less complacent, but not nervous. That's harder to read!
Bond traders, on the other hand, are getting a little nervous. That's bad!
We're simply in a weird place. I'm not sure that the market is ready to break down, but dip buying is riskier now than it was back in August, September, and January.
Beware.
