Too Much Optimism Could Lead to Stock Market Crash
A stock market crash may not seem likely when key stock indices are soaring and making new highs. But don’t get too complacent. The Chicago Board Options Exchange (CBOE) Volatility Index (VIX), often referred to as the “Fear Index,” suggests that we are on the cusp of a major stock market crash.
The chart below, showing the recent history of the Fear Index, is quite telling.
Chart courtesy of StockCharts.com
The Fear Index currently sits at its lowest level ever recorded. What does this mean? It means that investors are severely optimistic, and that the idea of a stock market crash is not a concern for them.
But, as you can see above, the VIX has truly been a great indicator of stock market crashes.
Whenever the VIX dropped below 15.0, we had some sort of a bubble already in the making, and then a stock market crash following a few months later. The further that the VIX fell below 15.0, the bigger the bubble that existed, and the bigger the crash that followed.
For example, look at the Fear Index between 2004 and 2007. It remained low for three years, but, in the midst of it, we had the housing bubble in the making. Investors were severely optimistic and the stock markets were soaring.
However, just few months later, after the VIX bottomed, a stock market crash followed. In this crash, key stock indices like the S&P 500 and the Dow Jones Industrial Average (DJIA) fell by more than 50%.
In more recent history, since 2014, the VIX has been trending lower. In fact, it just hit its lowest mark ever recorded.
Dear reader, I believe that the VIX is telling us we have a stock market bubble of epic proportions. That raises the question: “When will the inevitable stock market crash happen?”
Irrationality can go on in the market for some time, but the market always regresses to the mean.
It’s impossible to predict the exact time of the next stock market crash, but odds are, the higher that the key stock indices go, the bigger the crash we will see.