There is a sense of FOMO in the stock market


The stock market is rallying straight up and all the intraday dips are being bought. Yesterday we demonstrated that the most likely target is a 50% retracement, before the stock market either pulls back or retests. We continue to hold that view, with the important caveat that the short term is always harder to predict than the medium-long term. That’s why we focus on the medium-long term and mostly ignore the short term.

Go here to understand our fundamentals-driven long term outlook.
Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

FOMO

We’re not big fans of sentiment. Sentiment doesn’t give you a long term outlook, and sentiment only works at extremes. (And sometimes, sentiment fails at extremes because “extreme” can become even more extreme. That’s the same thing as catching the falling knife and slicing your hand).
Regardless, the popularity of sentiment indicators has surged in recent years.
One popular sentiment indicator is the AAII Sentiment Survey.
In the survey’s latest reading, the % of bears has rapidly plunged from above 50% to below 30% (as the stock market rallied).

Such a rapid drop in bearish sentiment is extremely rare.
From 1987 – present, it has only happened once: January 4, 2001

That was the first bear market rally in the 2000-2002 bear market.

N = 1, so take this bearish sign with a grain of salt. At the very least, it isn’t a long term bullish sign for stocks. Such a strong sense of FOMO is normal towards the end of bull markets. As retail investors and traders are conditioned by a 10 year bull market to constantly “buy the dip”, they see a 20% decline as a “once in a lifetime opportunity”.

5 days in a row

The S&P 500 is up 5 days in a row. Normally this doesn’t mean anything for the stock market. But it is slightly meaningful when it occurs while the S&P is below its 200 dma AND the economic expansion is in its late stages.
*Adding macro context to statistics makes the stats more useful.
Here’s what happens next to the S&P when it goes up 5 days in a row while under its 200 dma, while the Unemployment Rate is under 6% (exclude overlaps).
*Data from 1950 – present

The stock market’s long term forward returns are more bearish than random.

Strong reversal

The stock market tanked in Q4 2018 and has rallied vigorously since then.

What does this mean for the S&P?
Here’s what happened next to the S&P when it fell more than -19% over the past 3 months, and then rallied at least 10% over the next 3 months.
*Data from 1950 – present

The S&P’s forward returns over the next 2-3 months are a little more bearish than random (due to the probability of a retest), but returns after that are no different from random.
Macro Context
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*This is for members-only
Let’s only look at the late-cycle cases, in which unemployment was under 6%.

Once again, forward returns are not consistently bearish.
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VIX

VIX has reversed downwards very sharply as the stock market rallied.

Here’s what happened next to the S&P when VIX fell more than -40% over the past 10 days.
*Data from 1990 – present

This is pretty bullish for the stock market, especially 6 months later. HOWEVER, you can see that all the historical cases occurred from 2009 – present, in the context of a bull market. So take this bullish sign with caution.
Macro Context and what VIX did next
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*This is for members-only
Let’s only look at the late-cycle cases, in which unemployment was under 6%.

This is not consistently bullish for stocks on any time frame.
Here’s what VIX did next.


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Breadth

I already mentioned the problem with breadth indicators yesterday:

There is reason to suspect that breadth extremes are not as useful as they used to be. As ETFs gain popularity, it will become easier and easier for the market to register breadth extremes. So when a breadth extreme occurred at the end of bear market in the past, it might occur in the middle of a bear market today.

Regardless, breadth indicators are one tool in a technical trader’s arsenal.
Here’s a 10 day moving average of the # of S&P 500 stocks that are advancing. Notice how it plunged as the stock market crashed in December 2018, and is now soaring as the stock market is rallying.

Here’s what happened next to the S&P when the 10 day moving average reversed from under 150 to above 320 within 4 weeks (i.e. a short amount of time).
*Data from 1998 – present

This study leands bullish for stocks.
Macro Context and what VIX did next
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*This is for members-only
Let’s only look at the late-cycle cases, in which unemployment was under 6%.

The only similar case was August 2002. But at that time, the S&P had already fallen -50%. Clearly much different from today.
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Click here for yesterday’s market study

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction is still bullish  (i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration.
  3. The stock market’s short term has a slight bearish lean. Focus on the medium-long term because the short term is extremely hard to predict.

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.

Our discretionary outlook is not a reflection of how we’re trading the markets right now. We trade based on our quantitative trading models.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
Click here for more market studies