Stock Market At Critical Moment As Master Sentiment Indicators Slowly Improve (NDX)

In this article, we update the two master sentiment indicators, and then detail two likely market outcomes.

The Master Sentiment Indicators

The master settlement indicators are composites made from other, well tested sentiment indicators. The theory behind these sentiment indicators is the theory of contrary opinion. The MSI is long term, while the ST-MSI is short term. The methodology and concepts behind them are fully explained in this (earlier article).

Since September 30^th and October 7^th, when the two master sentiment indicators registered their most extreme readings, the S&P 500 is up 14% and 12.3% respectively. These moments were highlighted in this (October Article).

The MSI

As the 16 year chart below shows, the latest MSI reading is minus 5.8, which is just slightly out of the extremely bearish green zone. The green zone starts when the MSI is more than 90% of its historical extremes.

As the graph shows it’s been in and around the green zone for most of last year. The current reading means it’s more than 78.3% of its historical readings, which go back to 2007. Zero on the scale is 50-50. Extreme bullishness is below 10% of its readings.

The black arrows indicate higher bearish green zone readings on this index over the last 16 years. Each one was a major buying opportunity. Readers should look up and read those two prior articles for a fuller explanation.

The table below the chart shows each one of the nine sentiment indicators that make up the composite and where they currently stand on the SK ranking scale. The equity puts to calls ratio and the sentiment survey of American Association of Individual Investors are still registering extremely long term bearish readings. According to the theory, this is bullish.

The ST-MSI

The short-term master sentiment indicator is composed of seven different sentiment indicators, and is calculated on a daily basis. It’s intended to signal short to intermediate term market moves. As of last Thursday, the ST-MSI reading was minus 4.7, which is still relatively bearish considering the size and length of the current price advance. The number means the composite is more than 73.6% of its historical numbers measured over 15 years. The green zone is 909%. A neutral reading would be 50%.

The table following the chart shows the status of the seven indicators that make up the composite. The high amount of buying in the ProShares bear funds is keeping this indicator near the green zone.

Both sentiment indicators suggest this stock market has been rising against a “wall of doubt and worry.” This “tension” is one of the classic signs of the start of a new bull market.

Likely Outcomes

The most obvious thing while looking at the chart of the S&P 500 is how small this one year decline appears against the backdrop of the previous advance. To us the chart pattern looks like a high level consolidation after a big advance with everyone becoming bearish.

We remain extremely bullish after sentiment readings during the summer matched the highest bearish readings ever measured in 50 years. To us, it calls for a minimum price move of the S&P 500 back to the January 3^rd 2022 high of $4,742. That would be a gain of 16% from here.

We don’t believe this is a bear market rally. Bear market rallies are usually accompanied by a rapid reversal of sentiment back to the bullish side, setting up the condition for another price decline. As you can see from the two indicators, we don’t currently have that. In fact, we have the opposite. With so many bears still around, there’s not enough sellers left to send prices lower, so prices almost have to rise, even with a moderate amount of buying.

If we are right and the S&P 500 gets back to $4,700, then the determination will be whether we’re going higher or back down again. In other words, this one year high level consolidation may not be over. But that decision is 15 percentage points away and something for another day.

Economics

Notice we haven’t mentioned the economics of the current situation. One never does with the theory of contrary opinion since the theory almost always forces one to go opposite the majority’s economic exceptions. It acknowledges that when too many people hold those expectations, history shows they are usually wrong.

That said, on October 25th we wrote the following regarding the economic outlook.

We think the data strongly supports the idea that the sudden rise in the CPI is over and that inflation and interest rates will gradually return to lower levels by next summer. If this proves correct, I think investor recognition of it will take place in stages over the next three months. But the Fed will see it too and we should also see a sudden policy shift in reaction to it. That would be the trigger. We’d be in a recession, rates would be ready to move down, and stocks, which always start up in the recession, would be 10% to 15% higher.

Unless there is some catastrophic situation such as an unexpected, nuclear event in Ukraine war, we still think this is correct.