Bearish Sentiment In The Stock Market Is At An Extreme. What This Means For Stocks

Bearish sentiment in the stock market is at an extreme right now. For example, the Put/Call Ratio is at its highest level ever. During such times, the stock market can go down more in the short term (when panic sets in, it’s hard to know the exact bottom). That’s why it’s always better to focus on risk:reward and remain unemotional.

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Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

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*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are walking blindly into the future.

No VIX spike

What’s particularly interesting about the stock market’s current -16% decline is that VIX hasn’t gone up significantly. This has some investors worried that the S&P needs to fall much more in order for VIX to spike, and only then will the stock market make a meaningful low.

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Here’s what happened next to the S&P 500 when the S&P fell more than -15% over the past 3 months, while VIX never closed above 30.

*Data from 1990 – present

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As you can see, this study is particularly interesting. This only happened in June/July 2002, near the bottom of the bear market (after the S&P fell more than -40%). In that historical case, the S&P fell another 10%, but that was the bottom of the massive 50% bear market.

A lot of our recent market studies have pointed to similarities between now and October 2008 (i.e. after the 40% crash). Such quick crashes so close to an all-time high are rare. They tend to happen near the bottom of bear markets. But at the very least, this supports the case for a mean-reversion bounce.

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