Saturday, February 1, 2020

#Sentiment Review $SPX

The old American idiom of a day late and dollar short is an phrase easily applied to majority's ability to time (buy or sell) US stocks. The majority, influenced more by instinctual behavioral tendency of the individual to seek acceptance of an emotionally-driven crowd than act independently in the minority, views rising and falling stocks prices as bullish and bearish. This tendency that drives them chase when probabilities favor fading relegates the majority as the consistent bagholders of history's panics and trend changes.

Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”, John Templeton

Subscriber Comments

Many stock experts are convinced that 10%+ correction from extreme sentiment is coming. The 600+ point decline on Friday likely marginalizes any challenge to this outcome.

Traders shorting stocks stocks are challenging the primary trend. Stocks primary trend is up. Trading against the primary trend can be frustrating or dangerous. The Evolution of the Trade only permits small nibbles against the primary trend when extreme energy builds materialize against an aging primary trend. Does an extreme bearish energy build exist for stocks (S&P 500)? Is the primary trend aging? The answer is no for both.

US stocks have been rallying for months.  The rally slowly transitioned sentiment from pessimism WASo < 0 to optimism WASo > 0. The bears have been calling current sentiment extreme. The computer, however, cannot confirm it. Weight Average Sentiment (WAS) and Weighted Average Sentiment Smoothed (WASo) are the main measure of sentiment in the Matrix. The following charts are updated weekly for subscribers. WAS > 1.96 and WASo > 1 are extreme. WASo > 0.5 crosses the threshold of neutral sentiment.

Weight Average Sentiment (WAS)

Weight Average Sentiment (WASo)

The point of this discussion is not "everyone is stupid but us" but rather to challenge the prevailing logic that extreme sentiment makes a correction inevitable. Stocks could be vulnerable for other reasons, but extreme sentiment is not one of them.

The Weighted Average Sentiment Smoothed (WASo) reached 0.48 before Friday's big decline.  The most notable examples of similar highs after cyclical economic bottom were 2012 and 2016. All three periods have been highlighted green (see Weight Average Sentiment chart).

The next observation is simple. Sentiment turned pessimistic after WASo ~ 0.5, but price did not correct as expected. Perhaps it's different this time. Coronavirus, or Ralph Acampora, the Godfather of TA, calls for 10% correction has changed the game. What if today's setup is not different than 2012 or 2016; 2016 was an election year.

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