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ChartBrief 138 - Euphoria Peak

The August reading of the "Euphoriameter" showed a small but noticeable move down from what was a more than 12-year high, certainly a post-financial-crisis high. As a reminder, the Euphoriameter tracks a composite of surveyed investor sentiment (AAII & II), implied volatility (the VIX), and valuations (forward PE). This composite view provides a holistic insight across 3 distinct but complementary gauges of investor sentiment. The Euphoriameter helped signal a warning of the 2015/16 corrections, and correctly called the bottom in early 2016. So it is an interesting and useful indicator.

One important signal when watching sentiment indicators is to look for extremes, but perhaps more importantly, to look for an extreme which then begins to reverse. In that respect the latest reading is potentially quite important as a warning sign. As noted previously, when sentiment becomes euphoric like this, there is increasing scope for disappointment, as it simply reflects heightened optimism on the outlook. It also reflects likely higher than usual participation by investors, and indeed, the results of the State Street institutional investor confidence index of the past few months has shown North American investors are basically 'reluctantly bullish'- certainly on board. Volatility in the indicator is not unusual, but it is a shot across the bows, and a reflection of how quickly the mood can change...

The Euphoriameter dipped down in August after reaching a post-crisis high. The indicator shows high levels of optimism, and the risk is this optimism doesn't get matched by reality.

Institutional investor sentiment among North American fund managers had moved "reluctantly bullish" in recent months, and while the signal is less reliable it shows that these guys are basically on board.

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