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The Crash Confidence Index at Trader’s Narrative

The Crash Confidence Index

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While his work on valuation and bubbles receives more attention, Prof. Robert J. Shiller has been studying stock market sentiment for a long time. He has created several surveys which measure different aspects of sentiment. One of these is the Buy-on-Dips confidence index which we explored back in March. Unfortunately it has only about a 100 data points and doesn’t seem to provide much value added.

Today I wanted to check in with another one of Shiller’s surveys, the Crash Confidence Index. This new index, like the Buy on Dips confidence index, is limited in sample size but from the brief available data it seems to be provide much more insight.

The Crash Confidence Index is the percentage who think that “the probability of a catastrophic stock market crash in the US, like that of October 28, 1929 or October 19, 1987″ is less than 10%. So the higher the number, the less likely a crash is perceived as being imminent.

The highest level for institutional respondents was 58 on April 2006. While individual investors were the most confident on October 2003 when 49% believed that a crash was unlikely.

crash confidence index chart Oct 2009

Not surprisingly, we tend to extrapolate the present into the future so during the darkest days of the stock market, further catastrophic declines in the form of a crash appear more likely. During the low of the last bear market cycle (November 2002) the institutional respondents were very pessimistic (only 21% believe a crash unlikely).

During this bear market cycle, institutional investors were the most pessimistic in February 2009 while individual investors took longer to be persuaded that things were improving. They were most pessimistic in April 2009. Since then both camps have recovered sharply. However, if you notice, we are still at very low levels historically.

If we compare the sentiment during the recovery from the last bear market bottom the difference is remarkable. In the six months from November 2002 to May 2003 the institutional Crash Confidence index almost doubled while the stock market as measured by the S&P 500 had hardly budged at all.

Today, we have a stock market that has rallied almost 60% and yet, the Crash Confidence index in relation to that performance, has gone from 18 to 28. While that is a respectable recovery in sentiment as measured by this index, it is hardly commensurate for the performance that the stock market has lavished on us.

To learn more about the Crash Confidence index visit the Yale Center for Finance.

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3 Responses to “The Crash Confidence Index”  

  1. 1 wayne

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    Babak, posting here for lack of a better place, one thought regarding earnings

    I still think one of the best untold stories is recent guidance from LEI. Why are earnings coming in over estimates when we have had five sharp advances in LEI?

    09 March 98.0
    09 April 99.0
    09 May 100.2
    09 June 100.2
    09 July 101.0
    09 Aug 101.9
    09 Sept 102.5

    Just as Earnings estimates should have been sharply scaled down going into 2008

    07 July 104.6
    07 Aug 103.6
    07 Sept 103.7
    07 Oct 103.2
    07 Nov 102.2

    And I know the standard response is that LEI had forecast 12 of last 7 recessions. but these were unusually sharp trends in LEI. It is on my todo list, but there is a good story waiting here for someone who has time to properly tell it.

  2. 2 Babak

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    interesting Wayne, so you’re saying that LEI leads earnings? I haven’t looked into LEI much but perhaps it deserves more attention. Almost 80% of S&P 500 companies have beat earnings estimates during this earning season but then again that’s from sharply lower estimates. But, and this is a big but… most of that is coming from cost cutting not from top line revenue growth. Let me know if you find anything though.

  3. 3 wayne

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    yes, expanding on my comment,

    I was postulating as to why have analyst been so slow to upgrade earnings estimates, when LEI (and the stock market) have been strongly suggesting for 6 months that economy should be turning around.

    Just as why were analyst so slow to downgrade earnings estimates when LEI suggested strongly that the economy was slowing in fall of 2007.

    LEI is not infallible, but by definition “Leading” economic indicators should suggest future direction of economy, which translates into earnings.

    You can google Leading Economic Indicators for more insight. I have LEI data back to 60, but I am in the middle of another research project.

    Did you see the weekly unemployment claims # this morning also following link at CNBC

    Again for those who have studied LEI, I understand it has it’s faults, but how can you ignore the two very draconian trends in 09 and 07?

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