It’s 2008 all over again.
At least that’s what CNN Money’s Fear & Greed Index is telling us.
During the credit crisis, Lehman Brothers filed for bankruptcy and the Treasury Department placed Fannie Mae and Freddie Mac into conservatorship.
The stock market crashed … home values fell by more than 25% … unemployment rose to 10% … and our entire financial system was on the verge of collapse.
I’m sure you know the story by now. It was one of the scariest times in the history of the markets. Most investors sold stocks regardless of valuation.
Today, investors are just as terrified to own stocks. I understand why. The markets are down about 10% to start the year. And we still have another week left of trading in January.
But before you dump all of your positions, there is something you should know.
The last time the Fear & Greed Index hit these levels, the S&P 500 popped 10% in a month.
Let me explain …
The Fear & Greed Index is used to gauge the primary emotions that drive investors. This includes fear and greed — which are measured using seven indicators. They include:
1. Stock Price Momentum: The S&P 500 vs. its 125-day moving average
2. Stock Price Strength: Number of stocks hitting 52-week highs and lows
3. Stock Price Breadth: Volume of shares trading on the rise vs. declining
4. Put and Call Options: Trading volume of bullish call options relative to bearish put options
5. Junk Bond Demand: Spread between investment-grade and junk-bond yields
6. Market Volatility: Tracking the Volatility Index (VIX)
7. Safe Haven Demand: Difference in returns for stocks vs. bonds
CNN Money does a great job of combining all seven indicators and translating them into an easy-to-read system for investors. You can read more about it here.
This system is displayed on a scale from 0 to 100. A reading below 25 indicates investors are “extremely fearful,” with 0 being the most extreme. A reading above 75 indicates investors are “extremely greedy,” with 100 being the most extreme.
The Fear & Greed Index is used as a contrarian indicator. For example, when investors are greedy it’s usually a good time to sell stocks. And when investors are fearful it’s generally a good time to buy stocks.
Readers should be familiar with this index.
I wrote about it in these pages in September. This was shortly after the Dow Industrials fell 1,000 points in one day. The Fear & Greed Index hit 15 at the time. That’s an “extreme fear” reading, or usually a great time to buy stocks.
By the end of October, the markets surged 10%. That’s a major move for the large-cap index in such a short period.
If you bought stocks when investors were “extremely fearful” — you made a nice short-term score.
Today, the Fear & Greed Index is at 8, much lower than the 15 reading the index showed in September. That’s means investors are “extremely fearful” to own stocks.
Remember, this index is a contrarian indicator. The lower the number, the greater the chance stocks will bounce in the short term.
So don’t be surprised if we see another sharp rally in the near term.