Will Sentiment Become A Tailwind?

1.) BEARS – The S&P 500 has essentially gone nowhere for 5 months. And that kind of environment can be just as frustrating for investors as an actual decline. Like the old adage: “If they don’t scare you out, they’ll wear you out.” That’s mostly true for those without a strategy. So here the S&P 500 is just 3% from all-time highs, and yet we see investors are scared to death. The American Association of Individual Investors (AAII) releases its sentiment survey every Thursday morning. This week’s report really jumped off the page. Nearly half of individual investors say they are bearish on stocks over the next six months. That makes four consecutive weeks with more bears than bulls, with a major spike in pessimism in the latest reading from the AAII. So that gives us a read on retail, individual investors…but what about the “pros”? According to Goldman Sachs, hedge funds are currently carrying their largest short exposure since the end of the 2022 bear market, right before a strong rally in equities. Individual investors are bearish and hedge funds are heavily short, which brings us to the real question. What tends to happen when everyone is leaning the same way at the same time? Well, when everyone is bullish but fewer and fewer stocks are participating to the upside, that’s usually a recipe for a correction. Sometimes worse. But when everyone is bearish while the majority of stocks refuse to go down (like now), that’s often a recipe for higher prices.

2.) RATES – We’re finally getting sell signals on various rates (2, 10, 20, 30YR) after breaching those resistance levels I’ve talked about recently. The 10YR broke above 4.21% as bond volatility has remained high at 78.59 (MOVE Index). What’s next? Those rising bond yields are reading the likelihood that CPI could break to the upside. Considering how oil and many commodities have acted recently, a higher-than-expected CPI shouldn’t surprise anyone…but it will. For now, given the overbought conditions, it would not be surprising to see yields back off some while the market waits to be “surprised” about inflation. But at this point, I don’t think we should expect collapsing yields either. Yield spreads (difference between high yield/junk bonds and 10YR Treasurys) are starting to move up some as well. It’s not a problem yet, but rising yield spreads are not what bulls want to see.

3.) VOLATILITY – What VIX regime are we in right now? Chop, chop… sideways action. Volatility isn’t likely to all-out collapse from here. But I don’t think we are in a volatility regime north of 30 either. At the same time, I think it’s also clear we’re not in a sub-20 volatility environment. On one hand, I can see headlines continuing to appear that will keep people anxious. On the other hand, the biggest part of the conflict is already behind us. Implied volatility suggests a well-hedged market with a 96% implied volatility PREMIUM in place. That doesn’t mean markets can’t go down, just that well-hedged markets tend to not crash. To me, this market is just trying to “wear people out.”