After two jittery days on the stock market, Dow Jones Industrial Average (DJIA) futures point to a strong rebound on Tuesday morning. And despite rising geopolitical tensions, all signs point to a final, euphoric blow-out for the Dow and S&P 500.
CNN’s fear and greed index now reads “extreme greed,” the highest level in more than two years. Investors are greedily rushing into stocks to squeeze the last drops out of this decade-long bull market. The fear of missing out (FOMO) could push the DJIA into a melt-up phase, exploring new record highs, before the inevitable breakdown.
Dow futures contracts climbed a modest 39 points on Tuesday after a choppy overnight session. Traders appear to be brushing off fears of all-out conflict in the Middle East after Trump’s assassination of Qassem Soleimani.
The CNN fear and greed index is a tool that measures investor sentiment in the equity market. At a reading of 93, the index is flashing its highest level in two years. With the Dow and S&P pushing into record highs, investors are getting greedy.
What does this mean? It’s likely that retail investors will throw money at stocks on the back of positive headlines and new record highs. It’s a rough indicator of FOMO which could push the market into a euphoria phase.
Indeed, last time the indicator was this high, in late 2017, the Dow entered a blow-out run, chalking up a further 13% before correcting in early 2018. This is a classic late-stage euphoria sign.
Jeremy Siegel, professor of finance at the Wharton School of Business, has a similar take. He sees a possible melt-up in stocks as traders take on more risk .
One of the dangers is that people could be throwing risk to the wind and this thing could be a runaway. We sometimes call that a melt-up and produces prices too high.
Siegel told Barron’s Market Brief that stocks aren’t yet overvalued, suggesting there is room to make a euphoric run higher. The equity market, he argues, is still supported by low interest rates and relative trade peace between China and the US going into 2020.
Following any period of euphoria, there is the inevitable comedown. The stock market is no different.
Let’s look at the fear and greed index again. While an “extreme greed” rating often indicates a short-term flurry of buying, it almost always indicates a local top. Shortly after hitting the greed phase, there is a correction as the FOMO buying becomes unsustainable.
After the late 2017 ‘greedy’ run, the DJIA erased those gains in just three months, followed by the deep Christmas selloff later in the year (see chart above).
As Sigel warned:
If there’s a shock, you come down to Earth.