EC Vive La Résistance? Investor Sentiment May Tell The Tale For Stocks

Have we already witnessed the bursting of a stock balloon? Or, in contrast, have we merely experienced a volatile corrective phase in the continuation of the longest bull market on record?

According to research at GMO, the bubble has burst and there is more downside to come.

The author of a recent GMO white paper, Martin Tarlie, establishes effervescent particulars in a historical context. Specifically, when valuations become temporarily explosive — 1929, the late 1990s, 2017-18 — they are “averting the mean.”


Of course, “mean aversion” does not last. And reversions back to mean valuations tend to occur with extraordinary speed.

It is worth noting, however, that the 50% drop in the S&P 500 from 2000-2002 did not result in a complete reversion. On the flip side, the 50%-plus decimation in 2008-09 did move from 71% above the mean to 12% below it.

The takeaway here is that, even after the December destruction, traditional valuation methodologies peg stocks at higher valuation extremes than 1929 or 2008. Granted, lower rates may justify higher valuations to some extent, but not when the Fed leans towards rate hikes and quantitative tightening to reduce its balance sheet. And not when corporate debt-to-GDP is already at record highs.


The GMO white paper also discusses what causes bubbles to burst. They pop when sentiment shifts from positive to negative.

Many technical analysts interpret sentiment through market internals. For example, when there are more stocks hitting new 52-week highs than 52-week lows, sentiment is positive; when more stocks are hitting 52-week lows than 52-week highs, sentiment is negative.


Granted, 36.6 is a marked improvement from the big “zero.” Nevertheless, readings under 50 are generally regarded as a negative sentiment.

Another indicator? Bullish percentage. The greater the percentage of stocks in uptrends, the more positive the sentiment. The lower the percentage, the more negative the sentiment.

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Moon Kil Woong 8 months ago Contributor's comment

The good news is that the bears are still around but not that dominant and the bulls are around but are less than before. This means the market is liable to be relatively stable even though volatility is still higher than it has been. We will see what news drives the markets, but I don't think it will be too bad or too wonderful. Most people, like politics have already made up their mind about this market and won't change their minds unless something big happens.