A substantial majority of individual investors are concerned about a US stock market crash, but it is a positive fact. This is because breakdown anxiety is a contrarian indicator. It would be a bad sign if investors were confident that a collapse will not occur. We can therefore take at least some comfort from the current widespread concern about a possible collapse.
Today we are able to study the relationship between the stock market and collapse anxiety thanks to an index created on the basis of a monthly survey conducted among investors and prepared by the famous finance professor of Yale University. Robert Shiller.
The ‘Crash Confidence Index’ is on the rise as more investors are anxious about their portfolios.
The survey asks this question: “What do you think is the probability of a catastrophic collapse of the stock market in the United States, such as that of October 28, 1929 or October 19, 1987, in the next six months? “.
Shiller has published the latest results from which the percentage of respondents who believe the probability is less than 10% merge. Currently, 22.8% of individual investors believe this probability is low. Since 2001, the only time this percentage declined was at the end of the 2007-2009 and 2011 bear markets. These are certainly bullish precedents.
You might be wondering if meltdown anxiety is high because we are in October, the month of the two worst crashes in US history. But this is not explained. The latest reading is lower than all but three October since 2001.
Shiller’s survey focuses on investors’ subjective perception of the likelihood of a collapse. The real probability is lower. Much lower. Another research, conducted by Xavier Gabaix, a professor of finance at Harvard University, after analyzing decades of stock market history in the United States and other countries, has come up with a formula that predicts the frequency of stock market crashes for long periods of time. The formula worked very well in the two decades following its publication. Gabaix said the formula estimates that the probability of a 22.6% one-day collapse in stock markets is only 0.33% over a six-month period. This percentage was used because it is the figure the DJIA Dow Jones Industrial Average lost on October 19, 1987.
Because this percentage is so low, we know that the subjective probabilities reported in Shiller’s survey are almost exclusively a reflection of investor sentiment rather than objective reality. That’s why contrarians aren’t worried about the current high level of breakdown anxiety, and indeed see it as a positive sign.