VTV - A New Bull Market Or Big Double Top?

2023-05-31 01:00:19 ET

Summary

• History shows that investor sentiment is a better locator of market tops and bottoms than economic metrics, and that current sentiment levels support higher prices.
• We emphasize the importance of measuring investor sentiment with metrics like the master sentiment indicator, rather than relying on feelings or opinions.
• But how high will the market go? You trust sentiment. You simply allow the current rally to move higher and you don’t get worried until more people get bullish.

Is a nine month, 25% price correction enough?

Last year many readers commented that correcting the massive, three year, over stimulation package by the government should require more than a nine month, 25% bear market. Even though we’ve been bullish since last June, and still are, it’s hard to disagree with that.

Now, after a seven month market rally, many investors are doubting a recession and have abandoned their strong bearish convictions of last year. But they're letting price trends completely determine their outlook, and this can be wrong.

Markets tell stories

Stocks tell economic stories and economic stories can sometimes encompass many years. The series of flat bull and bear markets of the 1970s, which lasted twelve years, was the requirement to: first correct the speculative excesses of the late 1960s, and then price adjust for the double digit inflation that ended the decade.

A similar situation happened in the first decade of this century. We think a small version of it is happening now.

How should one invest for this?

Our answer: Let investor sentiment be your guide.

History shows that intermediate and long term tops and bottoms of the market correlate better with market sentiment than any economic series or metric. Yet it is one of the least explored areas of investing.

At Sentiment King, our main goal is to gauge investor sentiment in every way. The only path to understand what investors are thinking and doing is through statistics that directly reflect their activity and thoughts, not through economic analysis.

We've been 100% bullish on the market since last June only because of investor sentiment. By summer and autumn statistics showed there were simply too many bears. So prices had to go up. But to hold this view one had to set aside the overwhelming belief of a coming recession and rising rates.

Don’t talk about sentiment, measure it

Many people talk about sentiment but to use it you must measure it. Without numbers and charts, it has no real meaning.

We’ve created two master sentiment indicators, one long term and one short term. They’re composites made from many other sentiment indicators, all combined in a consistent manner. A full explanation is found here .

Nine indicators make up the master sentiment indicator and seven the short term master sentiment indicator. One is updated weekly, the other daily.

This is a chart of the long-term master sentiment indicator. It’s a composite of nine indicators. Black arrows point to past moments of extreme bearish sentiment, including the two moments last year that prompted our bullish forecast.

Notice where the index is today. Also notice that major declines don't start until the MSI is in the red zone, which represents high levels of bullish sentiment.

This indicator tells us that even though we've had a seven month rally, investor sentiment is still not bullish enough to support another major price decline, so we have to assume prices will continue to move even higher.

This next chart shows the short-term master sentiment indicator. It's a composite made from seven indicators.

It shows about the same pattern as the master sentiment indicator with the current reading of -.2 halfway between the extreme red and green zones.

We can't imagine another major market decline starting with this level of investor sentiment. So, this second sentiment indicator also points to a continuation of the current rally.

A new bull market or a large double top?

If market sentiment suggests that prices will continue to go higher, what is this rally? The simple answer is that it’s the start of a new bull market. But the incompleteness of the economic picture suggests the rally could be part of something a lot more complex. It could be a mini bull market that separates two declining wave or bear markets. A mini bull market that doesn’t go to new highs but brings prices back to the previous high on the S&P 500 of 4,800. It would then form a double top.

So, which is it – the start of a new bull market or a double top before prices start down again? If you let sentiment be your guide, you don't have to know the answer.

You allow the current rally to move higher and don’t get worried until more people get bullish. But the degree of bullishness can’t be based on a feeling or an opinion, you need a metric like the master sentiment indicator to measure it.

Our Expectation

While we said we don't have to know the answer we can help voice our opinion of what it is. We think we're in the process of forming a double top and we've diagrammed it below. We believe it's the most probable outcome.

We think this pattern fits with the current economic situation. We'll follow the situation closely. We'll measure investor sentiment daily, especially if we get close to 4,800 on the S&P 500.

At that time the answer to the question will become much clearer.

For further details see: