Why are analysts saying that the market is overly bullish?

Data from the CBOE indicates that the put/call ratio has been on a steady decline for the last 8 years. This seems to indicate that the markets have had increasingly bullish sentiments. The common perspective is that the market will soon hit its peak and investors should start to adopt a more bearish view.

Consensus Estimates:

Consensus estimates of the forward growth rate indicates that SP500 will continue to rise, bringing operating earnings per share up as well. This means higher future earnings, which was also reflected by the higher projected PE ratio. Critics would point to the growth rates being inflated during the beginning of the year then adjusted downwards as individual quarters approach, which could mean that growth rates are too high and too positive. However, negative adjustments while many, are often small scaled, which would not dent earning growth significantly.

 

Bubble Psychology:

To investors, one of the main indicators of a financial bubble would be abnormally high prices for equities or low yields for bonds. However, prices themselves do not constitute a bubble. The overly high prices must be accompanied by the continued over-optimism of the market. Hand in hand, upward looking investors will drive current high prices even higher, which will inevitably result in a crash.

In a survey conducted by Investors Intelligence, they observed that the bull/bear ratio on June 26th was 1.76, a number that is higher than the average ratio for the past decade. This sparked claims that the market was overheating. However, upon closer examination of the data, we can see that both the bullish and bearish percentages have dropped, as more investors take on a neutral view.

In fact, as we can see from the YTD bullish percentages, bullish sentiment has fallen, with the current value of 33% nowhere near January’s high of 55%.

This seems to point towards opportunities for further growth, with the current pessimism being a deterrent to the forming of the financial bubble.

However, it seems that markets are not overtly bullish, which seems to point towards the lack of a financial bubble.

VIX: Are investors complacent?

VIX, the measure of S&P’s volatility has been fluctuating between 21 percentage points and 11 percentage points over the past year. This indicates an expected fluctuation of 3.175% to 6.062% over a 30-day period.

Some might point to the new low on VIX as investors becoming increasingly complacent on the back of SP500’s good performance, and buying less stock options as insurance (hedging less) against potential losses. This would be worrying for the market, as it would leave investors exposed to a crash.

However, when viewed along with the falling put/call ratios, we can reasonably conclude that investors could be buying more call options instead of stock options to protect themselves against potential downsides. Demand for put and call options have been rising, as observed from CBOE’s Skew Index, which has recently reached a 15-year high. The index measures the curve of implied volatility across different strike prices, the higher the index, the higher investors are paying for options. If there weren’t people buying options, there would be no need for prices to rise.

Therefore, as option prices rise, we can conclude that investors are still shielding themselves from exposure. This means that small dips in the market would not send too much panic selling in the market and cause the bubble to pop. Investors can take heart in that.

SP500 Streak

A common indicator that Chartists look at would be the relationship between the SP500 price level and its 200-day SMA. If the SP500 breaks below the 200-day SMA, it is normally regarded as a sell-signal while a price level above the 200-day SMA is looked on as a buy-signal.

Fortunately for bullish investors, SP500 has now been trading above its 200-day SMA for 408 days. This unbroken streak is the second longest in history, with the longest at 525 days. With the SP500 is trading 7.4% higher than the moving average on July 2nd, it also does not look like ending.

Conclusion

It is understandable that investors would feel that a careful and bearish approach to trading is required in light of new market highs and talk of financial bubbles. However, based on further analysis, the market crash is not as imminent as one might think. Investors could benefit from adopting a more bullish stance.

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