More and more indicators are moving to risk-on

Key points:

• The Sentimentrader Risk-On/Risk-Off indicator cycled from less than 20% to greater than 75%
• Similar reversals in the composite preceded solid returns and win rates across all horizons
• An update to the Volatility Index (VIX) research note from last week

The weight of the evidence is building in favor of risk-on conditions

Over the last seven trading sessions, the Sentimentrader Risk-On/Risk-Off composite, which measures the percentage of indicators considered to be risk-on, increased by 33% to the highest level since January 2022.

With more members signaling risk-on conditions, the composite cycled from 0% in June 2022 to more than 75% at last Friday's close.

Similar to other indicators like the % showing excess optimism or the Volatility Index (VIX), the Risk-On/Risk-Off composite has shifted to a level more indicative of bull markets.

Similar reversals in risk-on conditions preceded a bullish outlook

When the Sentimentrader Risk-On/Risk-Off indicator cycles from less than 20% to greater than 75%, S&P 500 returns, win rates, and z-scores look excellent across most time frames. However, one must remember that a handful of signals triggered near peaks in significant drawdown periods.

The max loss over the next two months shows benign drawdowns since the low in 2009. Before that point, the shift in risk-on conditions was susceptible to a whipsaw signal.

The Volatility Index (VIX)

Last week, I published a research note that shared the outlook for the S&P 500 after the Volatility Index (VIX) closed at a 2-year low. A subscriber wanted to know what happens when the VIX closed at a 2-year low and it was less than 14, which occurred on 2023-06-06. 

A week later, the S&P 500 tends to take a breather. However, the results are nothing short of spectacular over the next six months. And the signal has never happened in a bear market. 

Eleven precedents took place in 2004 and 2005 when the Federal Reserve was raising interest rates, with the last instance occurring after the 9th hike.

I did not screen out repeats. The table includes every 2-year low with the VIX below 14.

Don't fear the rising volatility

The S&P 500 can rally despite intermittent spikes in the fear gauge. 

What the research tells us...

The Sentimentrader Risk-On/Risk-Off indicator cycled from less than 20% to greater than 75%, indicating increased risk-on conditions typically found during bull markets. After similar reversals, the S&P 500 rallied consistently over the next year, except for a few untimely precedents during significant drawdown phases. The Volatility Index (VIX) closed at a 2-year low and below 14, which is a bullish development for stocks and suggests the bear market is over.