Using Fear Indices to Forecast the Equity Markets

For Professional Clients Only. Not Investment Advice. For Information Purposes Only.

Good Afternoon, We have conducted a study comparing the CSFB Fear Index and the S&P 500 Index. The CSFB Fear Barometer measures investor sentiment by pricing a zero cost collar option strategy. The higher the level, the greater theperceived fear in the marketplace. As you will see from the chart below, the index has exceeded ~26.5 on 5 occasions since the beginning of 2010 to date, and once between 1994 and 2010 - so 5 prior occurences in all across ~18 years. The fifth is occurring now. Naturally, time will tell if this level augurs well or poorly for the equity market. However, on the previous 4 occasions, the S&P subsequently performed as below:-

June 2010 - S&P drop from 1117-1022
March 2011 - S&P drop from 1343-1279
June 2011 - S&P drop from 1363-1271
August 2011 - S&P drop from 1345-1123

The caveats are that the drop did not occur instantly, with months elapsing before the eventual fall in some cases. Additionally, in some cases the market increased in value by a tangible amount before the eventual fall. So, for anyone trying to implement this idea in the form of a naked short, we would suggest that you buy yourself time and restrict the leverage so that you are prepared if the position goes against you initially. We do have belief in this trade but on a total return basis after an up-to-12-month holding period, much like any other investment trade. Those with long portfolios may consider buying some portfolio protection based on this.