How crazy is the market?

Introducing the Crosby Irrationality Index

Jan 3, 2014 @ 12:01 am

By Daniel Crosby

It's a question we've all asked in light of the eye-popping gains realized in 2013. And while there is no shortage of economic indicators (the Fed releases over 4,000 each month), it can be hard to synthesize these into a meaningful and concise measure. It is toward just such an end that we have developed the Crosby Irrationality Index, a 0-to-100 measure of market fear and greed.

The Crosby Irrationality Index combines a number of fundamental and technical indicators indicative of market psychology and weights them relative to their historical predictive power. As a result, we also are able to report implied returns for one-month, one-year and three-year periods based on the current level of market fervor. These implied returns should be understood less as specific return predictions and more as evidence of economic head or tail winds.

The implied returns are indicative of what we might expect given the current level of market irrationality, all other things being equal, which, of course, they never are. For example, the current implied returns for three years from now are -6.817. While I'd never bet that the realized returns would be exactly -6.8 for that time period, the strength of the negative prediction does give me pause when considering how best to invest.

But enough already, you're here for the index score, which is as follows:

The Five Strata of the Crosby Irrationality Index

Revulsion — 0 to 19 CII

Watchfulness — 20 to 39 CII

Equilibrium — 40 to 59 CII

Optimism — 60 to 79 CII

Mania — 80 to 100 CII

The Current CII Score is 75.8 (optimism approaching mania).

Implied Returns

One month — -0.1061

One year — -2.598

Three years — -6.817

Many financial professionals have expressed to me a belief that market valuations are at a level approaching mania and our quantitative analysis bears that out. These scores are as of the end of 2013 and we will provide new data each month, so please stay tuned. If you have questions regarding the CII or would like the index delivered via the South Gotham Times monthly newsletter, I can be reached on Twitter @incblot or via email at Daniel@incblot.org.

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