2023-03-12 11:05:22 ET
Summary
- Ratios that measure bear market activity, like investor buying of "put options" and ETFs that short the market, indicate higher prices.
- The two Master Sentiment Indicators that broadly measure investor sentiment are both positive.
- This moment is a wonderful test of what "wins" when forecasting market direction - measuring investor sentiment or considering the economic outlook.
This is a follow-up article to this earlier one , which contains additional detail on the individual indicators that make up the two Master Sentiment Indicators, as well as how they're put together.
The Short-Term Master Sentiment Indicator (ST-MSI)
The short-term master sentiment indicator, a composite made from seven, well-tested sentiment indicators, still points to higher stock prices. The indicators that form the ST-MSI are calculated daily and responds to short-term changes in investor sentiment.
Three of the indicators - the five day, equity "puts to calls" ratio and the two ProShares "bear to bull" buying ratios - are in the green zone. This is seen in the table. The green zone represents moments of extreme bearish sentiment and indicate major buying opportunities.
The ST-MSI itself is at - 6.5. It is rapidly approaching the green zone, as you can see in the historical graph below.
The graph plots the ST-MSI against the spider S&P 500 ETF from 2016 to present. The black arrows point to moments when the indicator moved into the Green Zone. Almost all occurred at or near significant, intermediate-term buying opportunities.
The current reading of -6.5 is indicated on the chart in yellow. It's had a rapid swing toward the green zone over the last few weeks. We believe this rapid rise in bearish sentiment indicates that the market is going through a short-term correction and not starting another down wave of the bear market.
The Master Sentiment Indicator ((MSI))
We have a second sentiment indicator called the Master Sentiment Indicator or MSI. It too is a composite made from nine different sentiment indicators. Most of the nine indicators are updated weekly. Changes in this indicator occur more slowly and therefore are indicative of longer term trends in the market. The table below shows the current reading of each of the nine indicators.
Three of the sub indicators are in the Green Zone - the 20 day equity puts the calls ratio, buying levels in the Pro Share S&P 500 short fund and bearish levels of the American Association of Individual Investors sentiment survey. Five of the sub indicators are at neutral readings. The MSI itself is at -4.2.
The graph below shows the MSI plotted against SPY back to 2007. The graph clearly shows the close correlation between green zone readings and major lows of bear markets. The two readings in this bear market indicated by the last black lines on the right occurred last July and October. We believe those long term buy signals are still in force today. Looking back a year or two from now, we think will show those two moments as being the lows of this bear market.
What will prove right - Economics or Market Sentiment?
Warren Buffett said: "Be fearful when others are greedy. Be greedy when others are fearful." Notice he doesn't mention anything about the economy or the economic outlook in this statement; just emotion and feeling. He obviously feels that investor sentiment or emotion are more important than any economic reason making them feel that way.
People are fearful when the economic outlook is the worst. This is what makes investing difficult. Take the current situation. People are very fearful of a recession and things getting worse. They can't imagine that it is a good time to buy stocks with such a negative outlook. Yet, according to Buffett, the level of investor fear itself is sufficient.
So, this moment is a wonderful test of the theory of contrary opinion and what Buffett said, versus all the negative economic reasons people think this isn't a good time to buy. Only time will which side is right. We think the measurement of negative investor sentiment will win out and prove to be the best indicator.
For further details see:
Investor Activity And Market Sentiment Indicate Higher Prices