Stocks: Is Market Fear Nearing Its Peak?

S&P says extreme readings on key sentiment indicators may signal that we are much closer to a market capitulation than most people think

Global equity markets were in retreat Aug. 16 and investors are asking: How low will they go, and when will it end? Through Aug. 15, the S&P 500 fell nearly 10% since its July 19 closing peak. International indexes have also tumbled, with the MSCI-EAFE and Emerging markets indexes having fallen 9.6% and 9.0%, respectively, during the same period.

Lorraine Tan, S&P's Asian strategist, reports that Asian markets suffered their worst combined sell off on Aug. 16 since the subprime/CDO woes began, as program sales from global funds sent regional markets down across the board. Korea, which escaped the sell-off Aug. 15 as market were closed for a public holiday, was down 6% from the start and closed the day down more than 7%. Tan says this set the trend for the rest of the markets and the unwinding of carry trades and withdrawal of funds from Asia -- excluding Japan -- is all the more apparent given the strengthening of the yen against all currencies and the weakening of other Asian currencies against the U.S. dollar.

Tan says that while some local funds are sitting put, the program sales from global funds may continue to pressure markets for another day or so as money is repatriated to home markets to ward off potential redemptions. Even Shanghai was down more than 2% in signs that the Chinese investors are getting more wary of international events.

In the U.S., S&P 500 futures were off 19 points as of 8:00 am EDT, and it appears as if sell orders have been building since the end-of-trading-day decline in the previous session. But listening to the financial media (both radio and TV) this morning I couldn't help but catch a very clear sense of anxiety. The words "panic," "freefall," and "liquidation," as well as the phrase "blood in the streets" were uttered with regularity.

I can't help but think "How can the mood of the markets get any worse than this?" Maybe today's selling won't be the end, but I am beginning to wonder if we are much closer than most think.

Indeed, at the Aug. 15 meeting of S&P's Investment Policy Committee, Mark Arbeter -- S&P's chief technical strategist -– laid out the extreme level of fear, as seen in several sentiment indicators, and reminded us that they are registering readings that haven't been seen in 17 years! "While the market does not look or feel good from a subjective standpoint, the majority of sentiment indicators we monitor already reflect this emotion", says Arbeter. He points out that the CBOE equity-only put/call ratio spiked to 1.08 on Tuesday, the highest since 2004. The ISE Sentiment Index recently fell to an all-time low, indicating great fear in the marketplace.

Finally, adds Arbeter, there has been a huge increase in bearish sentiment on the Investor's Intelligence poll over the past couple of weeks, the largest since 1990.

As I said in my Aug. 15 comment,, I think we are experiencing a "correction of conviction," as investors question the faith they have toward our economy, markets and public officials. I also said that I think the Fed will continue to inject liquidity (and confidence) as needed, so be prepared for additional responses by Bernanke & Co.

In the end, I believe that even though the S&P 500 may decline a total of 10%-15% from its high before stability is reached, we believe time will eventually be the great neutralizer of this volatility. My confidence in our economic projections and earnings forecasts remains intact.

Before it's here, it's on the Bloomberg Terminal.