Bears Double As Fear Grips Wall Street

More Than Half The Losses Have Been Regained

This recent correction was the 4th quickest to -5% since the start of the bull market. That turned sentiment on its head as everyone freaked out about the trade war and economic weakness. In 3 days of rallies over half of the scary correction losses have been regained. The S&P 500 is down just 2.9% from its closing high. At the low this week it was down 6.8%. In this article, I will review how badly traders overreacted to such a small decline.

Huge Bearish Sentiment Swing

As you can see from the chart below, the percentage of bulls fell 16.8% to just 21.7%. That’s much lower than the long term average which is 38.5%. The percentage of bears literally doubled as it went from 24.1% to 48.2%. That’s much higher than the long term average of 30.5%. As you can see, the percentage of bears was the highest since December 2018 and the percentage of bulls was the lowest since December 2018. It’s a great sign for the market that a decline of slightly more than a quarter of what we saw last December was able to get investors to a similar level of fear. Based on sentiment alone, this market has little downside and a lot of upside even though the market is up a lot this year and the correction was modest.

It’s important remember when analyzing the bearishness of investor sentiment that by the time the data is released, it’s usually too late to buy the bottom. You can only look at the price action to find sentiment troughs. You can review sentiment indicators to find euphoric tops because tops are a slow process. It’s painstaking to watch the market top, while bottoms occur quickly.

The data in this survey was collected from last Thursday through this Wednesday. That means many respondents answered the questions near the market’s low. If investors were surveyed today, there would be more optimistic. It’s obviously not as good of a time to buy stocks now as it was at the bottom.

Investors didn’t have a positive opinion of the Fed’s rate cut as 30% said it was a bad idea and 23% said it was a good idea. I think investors are biased by the stock market’s reaction. If stocks would have gone up, we would have seen more positive responses. It’s a mistake to look at stocks to judge the Fed’s rate cut because stocks fell due to the tariff announcement, not the Fed’s decision. Stocks recovered after the initial decline last Wednesday.

Recession Coming?

Investors got very nervous after the modest correction because they fear uncertainty. The trade war and economic weakness is providing this uncertainty. The greatest fear is fear itself at this point. Small declines in stocks can send everyone scrambling because they fear a bear market. It’s surprising stocks didn’t fall more, like late last year. Compared to late last year, we have a more dovish Fed, a weaker economy, and more tariffs.

The Fed saved the market from worse declines, but investors aren’t giving the Fed any credit. One investor stated, “Feels like a bad decision. They should have maintained the rate so that there would be more room to adjust rates when needed.” It’s hypocritical to become very fearful of small moves in the stock market and then claim the Fed didn’t need to act. It’s like someone getting spooked and then claiming the thing that scared them wasn’t a big deal. Investors are stating that if the Fed didn’t acknowledge the weakness, it would have inspired confidence. However, when the Fed didn’t act last year, investors were skittish. It made sense for the Fed to soften the blow of the tariffs.

As you can see from the chart above, 60% of investors see a recession coming within the next 2 years. Only 18% see a recession in the next year. I think this survey speaks to bias because investors don’t like to stick their neck out and say a recession is coming in the near term, but they are always willing to say one is coming in the intermediate term. Even though this bias exists, I’m surprised so few see a recession within the next year because of the level of panic traders had during this correction. As I have stated previously, if there is a recession it will occur in the next few months. This is the window where risk is elevated. A recession can occur outside that window if the trade war gets worse. As I have mentioned, I don’t see a recession yet.

Review Of Thursday’s Action

As you can tell by the fact that most of the correction losses have been regained, Thursday was a great day for stocks. The S&P 500 increased 1.88%, the Nasdaq increased 2.24%, and the Russell 2000 increased 2.1%. Somehow the market is up for the week even though there hasn’t been any positive news on trade. The chart below details the wild swings since July 31st.

The VIX was down 13.24% to 16.91 as traders see this correction as mostly over. The CNN fear and greed index stayed at 25, which is extreme fear, because of the wild action even though stocks rallied. Every single sector was up on Thursday as it was a broad-based rally. Correlations are high. The best 2 sectors were tech and energy which increased 2.39% and 2.89%.

As of Friday morning, treasury yields were very low, and the curve was flat. The 2 year yield was at 1.59% and the 10 year yield was 10 basis points higher. The spread could go negative at any point in the next few days. That would be the first inversion in what was the most followed spread heading into the start of this expansion. The 30 year yield is at 2.22%. Earlier this week, it hit 2.12% which was about 3 basis points above the lowest yield ever. 

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