A New Market Sentiment Indicator

April 11, 2014

 

Since the AMSI most often finds itself in a neutral range, its effectiveness lies, in part, in offering perspective on both the level and drivers of that sentiment at a specific point in time. For example, high P/E and strong momentum were the principal factors in the high levels of AMSI complacency or readings during the height of the Internet bubble. Conversely, low-volatility and high-momentum readings were the main factors behind the complacency/greed period that preceded the credit crisis. The interaction of the different forces that drove AMSI sentiment readings in these examples (i.e., high P/E versus low volatility) demonstrate the value of a multifactor model over a single-factor model such as VIX or the put-call ratio.

Figure 7 provides a summary of the values of AMSI and its components before and after three extreme periods in recent financial market history—the crash of 1987, the Internet bubble and the credit crisis. Looking specifically at the time period around the crash of 1987 (Figure 8), at the end of August near the market’s peak, AMSI had a reading of about 70 (90th percentile), well ensconced in the zone of complacency indicating a heightened level of risk before the ensuing market crash. Net selling continued throughout most of September, with modest reprieves, before the catastrophic crash on “Black Monday,” Oct. 19, 1987. After the crash at the end of October, AMSI generated a reading of 12.3 (3rd percentile), suggesting that remaining in the market was warranted and that the selling was overdone.

Figure 7
For a larger view, please click on the image above.

Risk Parity

During the late stage of the Internet bubble in the second quarter of 1999, AMSI, bolstered by extremely high levels for the P/E ratio, provided a reading suggestive of too much complacency or greed. As the bubble began to deflate, momentum quickly dissipated and volatility surged, moving the AMSI toward neutral readings and ultimately toward anxiety and fear. As the three-year market decline initially triggered by the bursting of the internet bubble  began to bottom in late 2002, AMSI flashed readings below 25 (10th percentile), suggesting that fear was getting priced into the market and better times lay ahead.

 

 

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