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Are S&P 500 Bears Just Taking a Break?

Published 31/05/2023, 08:33
Updated 09/07/2023, 11:31

As one who tracks market sentiment, it still amazes me to watch it develop in real-time. And we see it quite well in the analyst community as well.

Let me give you an example. Many analysts have been terribly bearish for many months, expecting the next shoe to drop in the market almost any day. They have been looking for a crash just around the corner as the S&P 500 has rallied 20% from 3500 to 4200+. Week after week, many highly-followed writers have published dire warnings. Since we caught the low in October of 2022, I have felt quite lonely in my view that we will likely rally to the 4300SPX region off that October low.

Yet, now that we are approaching our target region, I am getting much more cautious and looking for the market to approach a major near-term top. And amazingly, many of those who have been bearish during this 20% rally are only now turning bullish.

To show you some further examples as to why it is usually misleading to follow analysts, in his book The Behavioral Investor, Daniel Crosby cited the following:

“[C]ontrarian investor David Dreman found that most (59%) of Wall Street consensus forecasts miss their targets by gaps so large as to make the results unusable – either undershooting or overshooting the actual number by more than 15%. Further analysis by Dreman found that from 1973-1993, the nearly 80,000 estimates he looked at had a mere 1 in 170 chance of being within 5% of the actual number.

James Montier sheds some light on the difficulty of forecasting in his “Little Book of Behavioral Investing.” In 2000, the average target price of stocks was 37% above market price and they ended up 16%. In 2008, the average forecast was a 28% increase and the market fell 40%. Between 2000 and 2008, analysts failed to even get the direction right in four out of the nine years.

Finally, Michael Sandretto of Harvard and Sudhir Milkrishnamurthi of MIT looked at the one-year forecasts of 1000 companies covered most widely by analysts. They found that analysts were consistently inconsistent, missing the market by an annual rate of 31.3% on average.”

Finance professor Robert Olson published an article in 1996 in the Financial Analysts Journal in which he presented the conclusions of his study of 4000 corporate earnings estimates by company analysts:

“Experts’ earnings predictions exhibit positive bias and disappointing accuracy. These shortcomings are usually attributed to some combination of incomplete knowledge, incompetence, and/or misrepresentation. This article suggests that the human desire for consensus leads to herding behavior among earnings forecasters.”

So, as many former bearish analysts have begun to turn bullish over the last few weeks, we may want to consider becoming a bit more cautious as we move toward our target region. Another topic I want to address this week was an article I recently saw asking if Elliott Wave works in this market environment.

If anyone has been following our Elliott Wave analysis closely, I think the answer is a resounding YES.

But, to begin with, to ask such a question evidences the questioner’s ignorance of Elliott Wave analysis. You see, Elliott Wave tracks market sentiment. And to question whether something that tracks mass emotion (as displayed through price action) works in the stock market is akin to saying that sentiment does not drive the market. So, as more and more market studies support the premise that sentiment is the main driver of market action, one has to question the true understanding of Elliott Wave analysis by the questioner himself.

Over more than a decade that I have been writing publicly, I have been challenged by thousands of newcomers regarding the efficacy of our work. They make unsupported and specious assumptions about how Elliott Wave analysis works and conclude that it must not work based on their erroneous assumptions. Their assumptions are usually based on a lack of knowledge or understanding of the appropriate manner to utilize Elliott Wave analysis. So, how much should we heed those who provide uninformed opinions?

Even many present themselves as “knowledgeable” in Elliott Wave analysis, yet their work displays only a very basic understanding of how the method works. As Alexander Pope noted, “A little learning is a dangerous thing." The other mistake people make is assuming that if our primary analysis is wrong, it is clear to them that the method does not work. Nothing can be further from the truth.

Our accuracy is at approximately 70%. That means we will be wrong 30% of the time. Yet, if one really understands how the market works, then you would understand that trading/investing successfully is about increasing the probability of successfully deploying your money while having an appropriate risk management process if the lesser probability path is taken.

And that is exactly what we do. Perfection in the markets, or in life for that matter, is simply a foolish expectation. It is an impossibility. And the sooner you can grapple with and accept that reality, the sooner you will be doing better in the market.

What I find truly laughable is that those that take me to task during the 30% of the time when I am wrong to have no problem following the analysts noted above, despite their pitiful track records. The cognitive dissonance displayed by the average investor is truly astounding when placed under a microscope. This has led to the constant superficial arguments we hear lately about the debt ceiling debacle and inflation.

First, I simply have to ask why anyone would even believe that resolution of the debt ceiling would cause a rally in the market. It would just place the market back into the prior status quo, which was a market moving sideways.

Second, many still view inflation as the market driver. As an example, I found this series of comments in a recent article:

“Hot PCE . .. and yet the market is soaring . . . So what’s the real reason market is steadily rising even if PCE is a little hotter than expected?”

Questions such as these display a lack of knowledge of market history. Do you not remember that we bottomed in October of 2022 on a hotter-than-expected CPI? Or do we simply ignore this fact? So, why does the market continue to rally on a hotter-than-expected PCE, as per the commenter? The answer is market sentiment.

As I have explained many times before, the underlying market sentiment shows how the market reacts to underlying news. And that is the simple reason why markets rally on bad news and drop on good news. So, despite a recent banking crisis, hotter than expected inflation data, and a potential debt debacle, the market has continued to rally because positive market sentiment has still not run its course to conclusion . . . yet.

So, over the last week or two, I provided you a support level in the 4100SPX region, which, if held, should point us up towards the 4300SPX region. And this past week, the market pulled back to 4104SPX and began another rally.

While I will not specify my exact target, I would say that last week’s low of 4104SPX is the key level to watch over the coming weeks. As long as all pullbacks hold over that level, I expect a rally toward 4300SPX and potentially beyond.

But breaking that 4104SPX support will open the door to the bigger pullback I expect as we look out several months from today. So, we will continue to ratchet up our stops as the market continues to subdivide higher. But, we are approaching the point at which investors should finally become cautious again, even though many analysts are now beginning to turn bullish.

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