What the Fear Index Is Telling Us About Stocks Now

Why This Stock Market Rout Is Here to StayOver the past few months, I warned my readers the stock market had become a risky place to be. While I also suggested euphoria could bring the market higher than most thought possible—to the point of irrationality—the bubble has now burst. Key stock indices are falling and fear among investors is rising quickly.

Please look at the chart below of the Chicago Board Options Exchange (CBOE) Volatility Index (VIX). This index is often referred to as the “fear index” for key stock indices. If this index rises, it means investors fear a market sell-off. If it declines, investors are complacent and not worried about the stock market falling.

Volatility Index Chart

Chart courtesy of www.StockCharts.com

In just the last 18 trading days (between September 19 and October 15), the VIX has jumped 122% and now stands at the highest level since mid-2012. It has also moved way beyond its 50-day and 200-day moving averages, which shows strength and momentum to the upside from a technical perspective.

Sadly, the VIX isn’t the only indicator telling us that investors don’t want to be in the stock market. Below you’ll find the NAAIM Exposure Index chart, a measure of equity exposure of active money managers (the so-called smart money).

NAAM Exposuer Index Chart

Chart courtesy of www.StockCharts.com

Active money managers continue to reduce their exposure to equities as key stock indices fall. On September 2, 82% of their collective portfolios were exposed to the stock market. Now, it’s only 33%. This represents a decline of 60% in their equity market exposure.

On the fundamental front, the stock market is constrained as well. Each day, we are seeing deteriorating economic data from around the world. We just learned retail sales in the U.S. economy for the month of September declined 0.3% from August. (Source: U.S. Census Bureau, October 15, 2014.) Retail sales have been subdued since the beginning of the year. And it means consumption in the U.S. economy is slowing.

The stock market had a great run over the past five years. While I expected the Dow Jones Industrial Average to more than double from its 2009 low of 6,440 to 13,000 and even 14,000…the Federal Reserve’s historic money printing program fueled the index to 17,000. This year will be the first time in five years when stock prices do not rise for the year. And small-cap stocks are having their worst year (in terms of percentage losses) since 2008.

Dear reader, when you have a stock market that rises when the Federal Reserve says it is going to print more paper money (out of thin air) and declines when the Fed takes that punch bowl away, you no longer have a stock market rising on the fundamentals of economic and corporate growth, but on speculation. And that’s what I have been warning about all along—real bull markets are not built on money printing.