It’s a bad sign that investors over the past six months have become much less worried about a U.S. stock market crash.
Last summer, 87% of individual investors thought there was a greater-than-10% probability that the stock market would suffer a catastrophic loss within six months — an all-time high.
Since then, that percentage has dropped to 71%, as you can see from this chart:
Those numbers come from a periodic survey introduced in 1989 by Yale University finance professor (and Nobel laureate) Robert Shiller. The monthly survey asks a representative sample of investors the following question:
“What do you think is the probability of a catastrophic stock market crash in the U.S., like that of Oct. 28, 1929, or Oct. 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.)”
Shiller and his colleagues report the results by tallying the percentage of investors who think the probability of a crash is below 10%. That 87% reading from last summer was the highest recorded since data began being collected in 1989. In other words, investors last summer were more worried about a crash that at any other time over the previous 32 years.
Contrarians have not been surprised that the stock market has performed so well since then, climbing the “wall of worry.” The Dow Jones Industrial Average
is 20.4% higher today than at the end of last August, and the S&P 500
is 19.4% higher.
Unfortunately, the latest reading of Shiller’s Crash Confidence Index, as it’s called, tells a less bullish story. The decline from last summer’s reading to today’s is one of the steepest on record. To appreciate why that’s bearish, consider the data in the following table.
With the decline since last summer steeper than 99% of all comparable periods in the Shiller database, the outlook for the next six- and 12-month periods would appear to be quite modest.
Other indicators flashing warning signals too
Shiller’s Crash Confidence Index is one of many sentiment gauges for the U.S. stock market. But most others are telling a similar story.
Another worrisome sentiment measure, as I pointed out earlier this week, is the huge flood of new cash into U.S. stock funds. Yet another is how expensive the U.S. stock market is relative to any of a number of measures of fundamental value.
Last month, you may recall, I focused on where the current stock market stands relative to eight well-known valuation indicators. The least bearish of those indicators still showed the U.S. market to be more overvalued than it was in 94% of all months since 2000. The most bearish shows the current market to be more overvalued than in 100% of those months.
The stock market’s current extreme overvaluation would suggest we should have become more worried over the past six months about at least a bear market, if not a crash. That investors are not is yet another indication of investors’ irrational exuberance.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected].