Is Stock Market Sentiment Too Complacent?

Here’s your “lost decade” update: The S&P 500 (ChicagoOptions:^GSPC) has risen nine out of the past 10 years and in 2013 just posted its best yearly performance in a decade. Have stock market investors become spoiled and overconfident?

Measuring the stock market’s mood or “sentiment” through news headlines, surveys, and data give us clues about the psychology of investors. Why does it matter? Because sentiment extremes (bullish or bearish) frequently point to major turning points in the market, and a high profit opportunity for alert investors to pounce.

Let’s examine three points that tell us about the stock market’s mood.

OverconfidenceAmong financial professionals, most CFA Institute members (63%) think the global economy will expand in 2014. Should this kind of confidence in both financial conditions and stock market prices surprise us?

AUDIO: 2014: Year of the Bear for Chinese Stocks?

Global stocks, as tracked by the Vanguard Total World Stock Index ETF (NYSEARCA:VT) climbed 17.12% in 2012 and added another 22.95% in 2013. The belief the hot streak continues is firmly rooted.

Curiously, just 40% of CFA members were optimistic about the worldwide economy in 2013, while even less (34%) were hopeful the year before. Will this year’s CFA survey, like previous years, turn out to be contrarian indicator for equity investors?

Subdued Stock Market VolatilityThe public’s fear of losing money in the stock market (NYSEARCA:DIA) has been replaced by the fear of missing out. That’s one way to describe today’s market psychology. And a lack of stock market volatility is a telltale sign of how wide spread the fearlessness has reached.

Wild swings stock market volatility, as measured by the CBOE S&P 500 VIX (ChicagoOptions:^VIX), have been nonexistent for three months. After spiking to 20.34 in early October, the VIX (NYSEARCA:VXX) has collapsed almost 39% back toward 12.

A world without volatility or fear isn’t how healthy markets operate. For prudent investors, the message is clear; a fearless stock market is a dangerous place to invest.

Record Margin DebtAs stock prices rise, investors are buying at higher and higher prices with borrowed money. NYSE margin debt has risen for five consecutive months and is at $423 billion – a record high! (see table above)

Almost every major market top, and subsequent correction or crash, is associated with excessive leverage and excessive risk taking. Never before in history has a voracious borrowing binge by investors with margin debt ever had a happy ending. Will this time be different?

The ETF Profit Strategy Newsletter uses technical and fundamental analysis along with market history and common sense to keep investors on the right side of the market. In 2013, 70% of our weekly ETF picks were winners.