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What trader sentiment tells us…so much bearish could fuel a bullish monster…did it start yesterday?

Markets exploded higher yesterday, with the Nasdaq beating the lead, up 3.5%.

As I write Friday afternoon, we are back to losses. All three major indexes are down, led by the Nasdaq’s 3.5% decline.

Much of the blame lies with yesterday’s weak Amazon earnings after the bell.

So what was yesterday then? Just a brief bullish flash in a larger sea of ​​selling? Or was it a precursor to a more sustained uptrend, despite today’s losses?

Well, we don’t have a crystal ball. But let’s start answering by looking at sentiment.

***Often, when a majority of investors all feel the same way about a particular market movement or upcoming direction, the reverse happens

You often see this at the end of a bull market. When everyone is bullish, everyone has put their money in the market. But that means there are no more dollars left to invest in order to keep pushing prices up. And so, despite the bullish sentiment, prices are falling.

This dynamic also often plays out in reverse. When all the bearish sellers have left the market, there is no one left to continue pushing prices down. So, any whiff of good news can push prices up.

There’s an old idea on Wall Street that the market tends to do what surprises and hurts investors the most.

Well, yesterday investor sentiment had turned so negative that gains were lagging.

Let’s look at some examples of this negativity, starting with something our tech experts John Jagerson and Wade Hansen of Strategic trader wrote in their Wednesday update.

Here they are to introduce the concept:

Traders (including you) can borrow up to 50% of a stock’s purchase price – according to the Federal Reserve Board’s Regulation T. This means that if a stock is priced at $100, you are only required to put up $50 of your own money to buy the stock. You can borrow the remaining $50.

Traders borrow money for their trades to increase their leverage or potential return in trading.

If you use 100% of your own money to buy a stock and the value of the stock increases by 10%, you will earn a 10% return on your money.

But if you only use 50% of your own money and then borrow the remaining 50% to buy a stock, you get a 20% return on your money if the stock goes up in value by 10%.

You essentially double your potential return when you borrow half the purchase price.

John and Wade point out that leverage obviously works both ways.

For example, suppose you only use 50% of your own money in a transaction and then borrow the remaining 50%. If your investment drops 10%, you suffer a 20% loss on your money. You double your potential losses.

Here is John and Wade’s logical conclusion:

Confident traders tend to increase leverage in their trades by borrowing more. They want to generate greater returns.

Nervous traders tend to reduce leverage in their trades by borrowing less. They want to protect their capital.

In light of this, we can track this leverage, or “margin debt”, to see how traders feel, which can have an outsized impact on the direction of the market.

*** What do margin leverage levels tell us about how traders feel?

Back to John and Wade:

Over the past two years, traders have shown extreme confidence in the US stock market by increasing margin debt to new highs.

Everything started to change at the end of 2021. According to the latest figures from FINRA, as of March 22, Wall Street has reduced its borrowing to just $799.7 billion to buy stocks (see Fig. 5).

It might seem odd to say “only” $799.7 billion, but as you can see in Figure 1, that’s down nearly 15% from the high of $935.9 billion that Wall Street had borrowed on October 21, 2021.

We don’t have numbers for April yet, but it looks like confidence is continuing to decline.

We wouldn’t be surprised to see margin debt continue to fall as traders strive to reduce risk and protect capital in their portfolios by deleveraging their positions.

Thus, we had traders feeling more and more bearish.

What about individual investors?

*** Where mom and pop traders think the market will be in six months

Retail traders weren’t feeling particularly bullish yesterday either.

We can see this by monitoring the research of the American Association of Individual Investors (AAII).

According to its reading (4/27), only 16.4% of AAII members were optimistic about the market situation six months from now. A whopping 59.4% was bearish with the rest neutral.

In some context, this is the most bearish level for investors over the past 12 months. This is also double the average downtrend level, which sits at 30.5%.

*** For more overly bearish sentiment, we could look to the recent put-call ratio

We won’t go into all the details but, in general, put options are a bearish bet on the market, while “calls” are a bullish bet. Examining the relationship between call options and call options tells us which sentiment controls.

Yesterday, the five-day average put-to-call ratio stood at 0.94, according to CNN Business, which is interpreted as “extreme scare.”

Additionally, as we highlighted yesterday, the S&P Relative Strength Index had just fallen into near-oversold conditions.

In the end, with so much negativity in the air, it was actually no wonder we enjoyed a monster relief rally yesterday.

The bigger question is whether this was the seed of a true bullish reversal, or just a pretense in a larger bearish decline.

*** What to do with yesterday’s rebound

On March 25, the host of popular investment show Mad Money, Jim Cramer, declared that “the bear market is over.”

The Nasdaq quickly rewarded its confident prediction by falling 12% over the following weeks. In fact, with today’s selloff, the Nasdaq remains at 11.5% since Cramer’s call.

So, let’s approach a market forecast with a little more humility.

As we noted above, given the extreme volume of negativity that arrived yesterday, we had to bounce back.

And given the continued negativity today, it wouldn’t be surprising to see more gains in future sessions after the market digests poor numbers from Amazon.

But we have to ask ourselves, beyond feeling too negative, what has really changed?

Yes, too much bearish sentiment can lead to a temporary bullish reversal in the market – that’s exactly what we saw in mid-March.

But for real and sustained gains, we need tailwinds from elsewhere to sustain a bullish move.

Think of it like trying to pedal a stationary bike. The tiny cogs will get you started, but they can’t get you going fast. These are the larger cogs that help you achieve real speed and momentum.

In the case of the market, an emotion-based relief rally is a good start. But that’s the small cog.

For the market to get back to the highs at the start of the year, we need the big cogs, which means positive news related to earnings, inflation, Fed policy and the removal of macro overhangs. wider areas of Russian and Chinese aggression. supply chain issues.

*** On that note, we learned this morning that the Fed’s favorite inflation indicator, the Core Personal Consumption Expenditures Price Index, rose 5.2% in March

Some analysts are calling this a win, as February’s reading was 5.3%.

Of course, while it is better to drop 0.1% than add 0.1%, the most important point is that inflation continues to burn in the economy.

Given this number, it is likely that we will see the anticipated 50 basis point rate hike from the Fed next week. And that’s even with yesterday’s negative GDP reading. (After all, consumer spending has been posting strong numbers, and that’s what the Fed is watching closely.)

But that 50 basis point hike is largely priced into the market today. The variable will be Fed Chairman Powell’s comment. Maybe the low GDP figure will sweeten things up a bit. Perhaps the unknowns surrounding Russian aggression will lead to a dovish attitude.

We don’t know – that’s what we’re going to watch.

Looking elsewhere, if earnings continue to surprise on the upside, this could give us a boost. That said, the market seems to tend to pay the same attention to forecasts for the next quarter. Case in point: Apple, which posted strong earnings yesterday after the bell but warned of a possible $8 billion supply chain hit in the next quarter. His stock is down about 2.3% as of this writing.

Fortunately, so much air has been pushed out of the market that valuations look much more reasonable today.

I know I am not offering a clear prediction of what will happen. And I know it can be frustrating. But there are just too many changing variables right now to declare that we are going up or down. I don’t want you Jim Cramer.

What we do know is that our first new piece of information that will give us direction clues will come next Wednesday, when the Fed releases its policy statement.

We’ll be following closely and reporting here in the Digest.

Have a good evening,

Jeff Remsburg

The post What to Make of Yesterday appeared first on InvestorPlace.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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