BNP Risk Indicator Flashes “Love” Warning Signal For US Stocks

While the market itself has exhibited the exuberance we have all seen before (and never seem capable of learning from), BNP has quantified this love-panic relationship (and the news is not great for the bulls). When in ‘love’ mode, the average drop in stocks has been 12% in the next six months. The biggest drivers of this “love” have been investor confidence, CoT positioning, short-interest, relative trading volumes, and sectoral outperformance with fund-flows shifting away from “love” suggesting the short-term top is in. The index itself peaked last week at the highest level of “love” in two years…

h/t @Not_Jim_Cramer

BNP explains their framework:

In our Love Panic model, we try to identify distress and euphoria in an attempt to predict forward market returns. In order to successfully predict the market we have chosen parameters with good predictive capabilities during different market cycles but also those that make qualitative sense. Investment should be dispassionate but not automatic. Some investors solve this problem by hiring a mechanic (or quant) to build a machine to invest on their behalf. This indicator is not for them. Instead, this indicator highlights when market sentiment is either overly depressed or excessively optimistic. This helps one at least adjust for ones mood. So we suggest that when the market has reached a level of distress, it’s a good time to buy. Meanwhile, when investors are euphoric,we advocate a sell. As a result we have developed a contrarian indicator model. When our signal is in panic (negative), it indicates a buy. While when the signal reads positive it’s a sell signal. In our Love Panic model, we try to identify distress and euphoria in an attempt to predict forward market returns. In order to successfully predict the market we have chosen parameters with good predictive capabilities during different market cycles but also those that make qualitative sense.

And the market has not done well once investors fall in ‘love’…