The Market Thermometers page can be accessed directly from the home page by clicking on the underlined Index Forecasts>> link. Some readers have taken to bookmarking the page on their browser for easy daily access.
It shows what the community of institutional investment strategists must collectively believe could happen to the prices of four major market indexes over the next few months. If their thinking was otherwise, they would be willing to pay different prices to hedge their at-risk exposures in each index.
Covered are the 30 Dow-Jones Industrials (DJIA), the S&P 500 (SPX), the Russell Small-cap 2000 (RUT) and the Nasdaq 100 (NDX). All are institutional benchmarks.
Before ETFs were available it was difficult, but possible, to invest in these indexes. Still, the price insurance markets of listed options in each of them have existed for decades.
We have used some of those evidences of intent since the ‘70s and ‘80s. They come from the investment industry’s best informed and most sophisticated professionals.
What you see in the display is the range of prices for each index that the pros believe are necessary to be protected against; prices that could be encountered under reasonable circumstances. Their high and low limits are arrayed across the top and bottom of the picture.
The red “temperature” column top marks where the index’s current price stands in that range. The higher in the range, the hotter the market action is currently. By implication, then more downside exposure exists.
In the center of the display is a vertical scale of Reward vs. Risk, where Risk refers only to market price risk, or downside threat. The scale is arbitrarily limited to ( 1 : 100 ) and ( 100 : 1 ).
While specific securities from time to time encounter prices that exceed their current forecast limits, this very rarely happens to indexes that are averages of dozens to thousands of stocks.
For the S&P500 the range of experiences across 20+ years is at its cheapest when ten times as much upside as downside is seen ( 10 : 1 ) . It is at its most expensive when three times as much downside as upside is expected, a ratio of ( 1 : 3 ).
The average reward to risk relationship for broad market indexes, as well as for all stocks, is slightly below ( 1 : 1 ), reflecting that investors generally prefer to sacrifice some return opportunity in order to avoid loss. Logically, when downside price prospects are larger than upside ones, the investor is taking on more potential problem than promise.
So when looking at the thermometers it is reasonable to regard markets as getting overheated when the red columns get above the ( 1 : 1 ) level.
That thinking holds true as long as equity investments are being driven by a value mentality. But not all stocks are priced that way. Some are dominated by a momentum notion.
This is particularly true in high growth technology stocks of the type that are prevalent in the Nasdaq 100 (NDX) index. So in that thermometer it is not at all alarming to see the mercury riding in the upper half of its tube.
Conversely, the NDX may see prices low in its forecast range as its constituent stocks decline rapidly in price. Instead of signaling bargains, this often presages continued falling prices.
This difference between value thinking and momentum ideas is why we always consult our actuarial tables of specific stock odds and payoffs when contemplating investment actions. But more on this point another time.
Market Thermometers
Market Forecasts, Stock Indexes
