This September has been disappointing for most equity investors. The broad-based S&P 500 index corrected roughly 5% and investor sentiment deteriorated further. However, those who read our most recent write-ups know that the recent correction wasn’t surprising. A 5%-10% correction has been overdue, according to long-term market statistics. The S&P 500 increased for more than 200 days without correcting at least by -5%. That’s more than double as long as the statistical average during the past century. Eventually, that run ended in September and the blue-chips index dropped by more than 5%. Therefore, it is reasonable to question at this junction if the rally resumes after a brief correction.
Negative Sentiment Is A Contrarian Indicator
Various sentiment indicators show extremely bearish readings. According to academic research, the good news is that extreme expectations often get disappointed and can be seen as a contrarian indicator. The survey-based individual investor sentiment index, AAII 4-week average for example, recorded it’s most bearish level in a year. That was before Thursday’s selloff. The print on the chart below is not yet extreme but more times than not, it did not pay well to be a pessimist on US equities at similar levels. Another drop or persisting volatility could deteriorate the indicator further until it sends a buy signal around -10.
Our big-data-based retail sentiment index confirms the AAII survey results. Retail investors’ sentiment diverged significantly from the S&P 500. The drop in sentiment is similar to that recorded during the Summer of 2015. A -15% correction unfolded in the S&P 500 back then. It was not justified by fundamental news flow and recovered swiftly after that. Likewise, active investment managers are getting a little more nervous at this junction. The NAAIM exposure index recorded a big drop from 78% to 55%. It was the lowest figure since May and recorded before Thursday’s selloff. Moreover, positioning is very volatile and reflects the recent moves in sentiment.
A closer look under the hood provides further hints for the broad-based bearishness among investors. While the major US indices are close to their all-time highs, individual stocks are not. More than 50% of Nasdaq Composite stocks trade more than 20% below their all-time high. Such a high number of stocks being underwater is typical during large selloffs or bear markets. However, that’s not the case today. Instead, the Nasdaq is very close to its all-time high. Adding that to the fact that most individual investors like to pick stocks makes sense why they are so bearish. That’s the case because they are most likely down on their stock picking portfolios during recent months.
The technical picture remains constructive but deteriorates. US equities are most likely not done to the upside. However, the optimal path leads slightly lower as Thursday’s selloff recorded strong downside momentum. Most likely, sellers are not done yet. Another 2%-3% lower lead the S&P 500 to the 4170-4240 S/R cluster. Further, a 23% retracement of the trend that started in May 2020 also coincides with that area. Moreover, the 200-day moving average is slightly below that area and could attract attention and liquidity during the next few days.
The Russel 2000 trades at its 200-day moving average already as the index went sideways since January. Most likely, the 2100 support, which proved its value five times this year will hold again. Technically oriented traders will notice a textbook triangle pattern on the Russel. These patterns resolve most often in the direction of the paramount trend. Therefore, traders are likely to step in and supply liquidity if we witness another drop towards 2100.
All in all, slightly more downside that reverses in a rally with fragile momentum is the most likely scenario. Bulls want to see a sustained breakout above 2300 in the Russel 2000 that gets confirmed across risky assets. That’s a high-confidence signal that the next leg up started.
Last but not least, there is a potentially interesting swing trade setup on the Russel 2000 at this junction. There is a low double-digit upside potential on if bullish sentiment gets back into the market. Consequently, the triangle pattern proves correct, resolves to the upside, and targets towards 2600 points.