Peak in fear may turn stock market around
By Matt Krantz
USA Today
If a good healthy panic was necessary to turn the long-suffering stock market around, did Wall Street finally get what it needed?
Yesterday, the Dow Jones industrial average surged 447 points to 8,712, extending its rebound the past four sessions to more than 1,000 points, or 13.1 percent. The Standard & Poor's 500 index is up 12.7 percent that same period, after rising 46 points to 899 yesterday.
As impressive as the rebound itself may be, what has some analysts encouraged is that it started with fear among investors at levels not seen since the 1987 stock market crash.
Until last week, market professionals had been befuddled by investors who remained calm despite losing trillions of dollars.
But last week, many of these nervous investors appeared to have surrendered.
While stocks fell to their lowest point in the bear market, the Chicago Board Option Exchange's increasingly popular volatility index, sometimes referred to as the fear gauge, soared to close at 50.48 last Tuesday.
This index measures nervousness with a complex formula that analyzes how much investors pay for financial instruments designed to cut losses.
Simply, the higher the number, the more fearful investors are. When the fear gauge exceeds 50, which it rarely does, that's considered an off-the-charts level of fear. Even after the Sept. 11 terrorist attacks, the fear gauge closed at just 49.04.
"People were frightened to death," says Robert Whaley, co-developer of the fear gauge and a professor of finance at Duke University.
The spike in fear is now causing some to wonder if investors have been scared enough to signal a bottom.
"(Fear) tends to get to its highs at the (market's) bottom," says Gary Tapp, director of quantitative analysis at SunTrust Robinson Humphrey.
And there are other signs of a fearful flight from stocks. Investors will have yanked a record $50 billion from stock funds in July once the month ends, according to an estimate by TrimTabs.com, which tracks money in and out of funds. The previous record outflow from stock funds was $30 billion in September, the Investment Company Institute says.
To put last Tuesday's close of 50.48 in perspective, consider that the fear gauge:
- Hasn't closed above 50 since Nov. 11, 1987, after the October crash. That day, it closed at 55.55.
- Closed no higher than 48.56 even during the Asian financial crisis in 1998.
The fear gauge alone is no guarantee the market is ready to rally again. Kenneth Winston, director of risk management at Oppenheimer funds, points out that last week's fear reading didn't get anywhere near the peak levels of 1987. The fear gauge hit 150 on the day of the Oct. 19, 1987, market crash, for instance.
Chris Johnson, managing quantitative analyst at Schaeffer's Investment Management Research, adds that other indicators didn't reach levels some say are needed to show extreme fear.
Investors hoping to quickly cash in on others' fear could also be too late. The fear gauge fell yesterday to 33.43. "People have been calmed," Whaley says.
And there's no guarantee that stocks couldn't get caught in yet another vicious downdraft. Company executives are nearing the Aug. 14 deadline to sign off on their financial statements.
"You know there are a few skeletons in closets," Johnson says. "I'm staying pretty skeptical."
