Investors Have Never Been So Worried That The Stock Market Is Going To Crash

Matty-Sways

Investors worrying is actual a good sign because investor sentiment is a contrarian indicator.

Historical data on investor beliefs about crash probabilities researched by Yale University finance professor (and Nobel laureate) Robert Shiller for more than 2 decades by surveying investor sentiment. He and his colleagues ask ...

What do you think is the probability of a catastrophic stock market crash in the U. S., like that of October 28, 1929 or October 19, 1987, in the next six months, including the case that a crash occurred in the other countries and spreads to the U. S.? (An answer of 0% means that it cannot happen, an answer of 100% means it is sure to happen.)

  • In August, the U.S. Crash Confidence Index (CCI) fell to a record low — at 13%, meaning that 87% of respondents believed the probability of a crash to be greater than 10%.
  • In September, the reading was a still-low 15%.

Strong statistical support for the contrarian interpretation emerged when I analyzed the CCI back to 2001 (which is when the survey began to be conducted monthly).

What we are going through now resembles the spring of 2009: however then the stock market was far less overvalued than it is today, as judged by the Cyclically-Adjusted Price Earnings (CAPE) ratio — if not outright undervalued. The market’s strong performance after the spring of 2009 might therefore have been a reaction to the market’s valuation rather than a contrarian reaction to the widespread crash anxiety.

Furthermore, Shiller added, there is a behavioral basis for concern: anxiety increases the chances “that a negative, self-fulfilling prophecy will flourish.”

I nevertheless cling to my analysis, since even after eliminating 2009 from the sample the contrarian interpretation continues to enjoy statistical support.

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Economics, Finance and Investing

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