Excessive Pessimism in the Stock Market can be Bullish, but the Price for U.S. Indices is not yet Oversold
Last Monday brought the expected bounce; however, the gap-up seen during such uncertainty suggested a prompt fill, which indeed happened later that same day.
Today, significant pessimism pervades the stock market. This analysis will balance this sentiment with price action, given that excessive negative sentiment has often preceded rallies in recent years, including during the 2022 bear market.
Let’s examine the average stock exposure reported by the National Association of Active Investment Managers. As shown in the chart below, which starts from 2022, allocations below 30% have historically preceded bear market rallies. For instance, a 6.5% short-lived rally occurred in May 2022, a multi-week 19% rally began in mid-June 2022, and the low allocations in October 2022 and 2023 coincided with market bottoms.
The good news for bulls is that such low allocations have been signals for bounces. Currently, the index is low, but not yet below the 30% threshold seen during those previous turning points.
Examining the expectation for a decline over the next six months, the current pessimism is remarkable and comparable to the past events we’ve discussed. As the dotted arrows on the chart illustrate, periods where pessimism exceeded 55% have historically coincided with significant bottoms for the .
Based on the two charts presented, conditions appear aligned for a bounce. However, price action is a crucial factor to consider. The bottoms mentioned for 2022, 2023, and 2024 (if including the carry trade selloff) all occurred when the price was oversold. In contrast, the bounce this past week has been weak and lacked conviction. This week will be decisive for the stock market, considering two aspects:
-
Bearish sentiment flags that a bounce can be nearby, but not the exact bottom (see the bottoms in May and June 2022 were days away from the sentiment reading).
-
Price action lacked conviction for a bounce last week (the long weekend could have affected it, but the charts don’t differentiate events).
On the other hand, a rare bullish event that happened two weeks ago for the 7th time in decades was studied and posted on my homepage. The advancing volume on the New York Stock Exchange reached 98.6%, indicating that an overwhelming majority of trading volume was concentrated in rising stocks.
Statistically, this has been analyzed as a very bullish signal. In fact, it was the seventh such occurrence since 1980, with historical data showing the price being higher three months later 100% of the time (averaging a 2.2% gain), six months later with an average gain of 4.9%, and one year later at 9.2%.
Dow Jones Chart
DJI: Last week’s setup appeared ready for a bounce. The annual $38.3K level held well as support, and the green candle initially suggested continuation or, at the very least, indecision (like a doji candle we’ve seen). However, today’s conviction in the red candle completely changes the landscape. This reflects a clear rejection from the monthly $40.4K level, coinciding with resistance from the weekly 5-period moving average.
The volume gap, highlighted by the double arrow, further supports the thesis of rapid moves between these key price levels (’shelves’). Additionally, the RSI is falling once more.
Based on this price action, the is suggesting potential downside next week. As long as it continues trading below $39,628, the stage is set for a decline towards $38,464 before the potential bounce suggested by the pessimism presented above. Conversely, regaining the $39.6K level could open the door to a bullish target at $40,305.
SPX Outlook: Balancing Bullish & Bearish Forces with 3 Key Indicators
The Dow Jones was significantly affected by , and the outlook is bearish, for SPX and , there is one difference in the chart that is worth considering:
Last week, I highlighted the bullish engulfing setups and the piercing candles, both with a bullish outlook, but for now, they didn’t present confirmation. The last candle for SPX (and NDX) tried to print the opposite of a piercing candle, which is a dark cloud.
The pure technical definition of a dark cloud indicates that a long bullish candle (as the previous one), is followed by a red candle on the second day that opens above the close of the first candle (a gap up) but then closes significantly below the midpoint of the first candle.
The midpoint was not covered, so even for a bearish candle, it can present positive continuation.
That pure technical definition has to be analyzed with resistance zones, and the SPX didn’t make it to the bullish target last week; it found rejection and lost $5,405, a monthly level that continues bringing the price down, even since April 9th, when it was temporarily crossed.
The Stochastic oscillator is printing a bullish crossover at the oversold zone in the weekly chart; similar to the sentiment charts, it may be suggesting a bounce could be brewing, but it was also the case in October 2023 when the bounce vanished and a lower low came before the bounce.
3 Elements to Watch to Consider a Bounce:
-
must break below 29
-
SPX has to recover $5,321
-
Percentage of stocks above 200 DMA above 30%
For more details, visit my homepage.
Have a blessed week.