QVMS - Sentiment Says Expect A Turnaround In 2023

Summary

• The market's sentiment profile is near historic lows by some measures.
• Contrarian principle says expect a major relief rally in 2023.
• S&P tends to significantly outperform in pre-election years.

Investor sentiment is about as bummed out and bearish as one could hope for, if the market is truly on the cusp of a turnaround. Of course, there are no guarantees there will be a meaningful reversal for stocks in the coming weeks and months—especially given the Fed’s stubborn insistence on “fighting inflation” (much to Wall Street’s chagrin). But the odds technically favor a better year ahead for the bulls, as we’ll discuss here.

Front and center on a recent cover of the Wall Street Journal was the headline , “Stocks Log Worst Year Since 2008.” The article pointed out that 2022 was a “bust for markets” and one of the worst years for equities in decades.

Bonds, too, had one of their worst sell-offs ever as interest rates skyrocketed, while cryptocurrencies crashed. Commodities, which started out strong, also finished on a sour note. It was basically a bad year all the way around.

One indication of how pessimistic investor psychology has become is shown by the near-record low readings in recent months in the AAII sentiment survey. As you can see here, AAII bullish sentiment has been hovering near the historical lows around 20% in the last few months.

For perspective, the record highs in the AAII sentiment poll are around 60% (rarely, if ever, higher), while the median is around 40%. What this chart demonstrates is that retail investors are far from expecting good times ahead in the coming months—and that by itself can be considered a clue that their expectations will be disappointed.

Even more emphatically is the Panic/Euphoria Model used by Jason Goepfert of SentimenTrader, which shows a near-record reading of panic among investors. Goepfert observed , “It has sunk far below that over the last couple of weeks. Thanks to plunging values in some of the inputs, the model exceeded -0.5 for one of the few times in its history.”

Goepfert went on to observe that future returns were “exceptional” whenever the model exceeded -0.45 for the first time in at least six months.

Not just stocks, but cryptos appear psychologically poised for a turnaround. The front-cover indicator once again reared its head when, in a recent front cover of the Wall Street Journal , the following headline appeared: “Crypto’s Onetime Fans Are Calling It Quits.” The article noted:

Crypto fund asset managers saw investors withdraw almost $20 billion in November, or nearly 15% of total assets under management, according to the research firm CryptoCompare. That brought the fund managers’ collective AUM to its lowest point in nearly two years.

This is significant from a contrarian perspective, given the tendency for bitcoin rallies to precede—or at least coincide with—stock market strength. (The speculative nature of cryptocurrencies is thought by some analysts to be the reason for this; thus, when bitcoin prices are on the upswing, the bullish fervor often spills over into equities.)

With this in mind, any rally from here in the Grayscale Bitcoin Trust ( GBTC )—my favorite bitcoin tracker—could serve as a “heads-up” for a sizable short-covering rally in stocks.

To get a sustainable rally in the stock market, however, will require some additional improvement in the market’s breadth profile. More specifically, we need to see the daily new 52-week lows on both major exchanges (especially the NYSE) shrink below 40 for several consecutive days to let us know internal selling pressure has dried up.

In the last two trading sessions (January 4 and 5), NYSE new lows were below 40 on both days for the first time in several weeks—a great start to the New Year to be sure. But past attempts in recent months at sustaining a healthy new lows reading have failed. We’ll see if this time proves to be the exception, but the improvement so far is a good sign.

Anecdotally, Santa’s failure to show up on Wall Street in December brings to mind an old saw by market statistician Yale Hirsch, who famously observed: “If Santa Claus should fail to call, bears may come to Broad and Wall.” The implication here being that no Santa Claus rally in December often precedes a bearish January. Yet that isn’t always the case, as Yale’s grandson Jeff Hirsch has proved. In a recent blog post from his Almanac Trader , Jeff noted:

…in pre-election years, Januarys have been outright stellar ranking #1 for S&P 500, NASDAQ, Russell 1000, and Russell 2000 and #2 for DJIA. Average gains range from 3.4% by Russell 1000 to a whopping 6.8% for NASDAQ. DJIA and S&P 500 have only declined twice in pre-election Januarys, 2015 and 2003.

Jeff further observed that “January has quite a reputation on Wall Street, as an influx of cash from yearend bonuses and annual allocations has historically propelled stocks higher.”

The bottom line is that what the coming weeks will look like is anyone’s guess, but I think we can say that—based mainly on the market’s sold-out sentiment profile—the market is due for a better year ahead after the “downer” year of 2022.

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