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One More Rally to End the Year


December 22, 2022

Knox Ridley

Portfolio Manager

Sentiment continues to show some of the most bearish readings we’ve seen since the 2022 bear market began. The AAII, which is a survey that asks investors if they are bullish, neutral or bearish 6 months out, just gave us the lowest reading of bulls since the October low.

Recently, only 24% of those surveyed are expecting bullish results over the next 6 months. Compared with the March low in 2009, this is not too far off that reading, which came in at around 19%.

US Investor Sentiment Chart

When we look at the options market, we are seeing a similar rare pattern that has only occurred two times in the last 16 years. This is when we see an outsized ratio of puts being bought while the market is in an uptrend.

S&P 500 Index Chart

Regarding the put/call ratio, any reading over one signals that more puts are being bought over calls. A reading over 1.1 is reasonably rare, which I would consider a fear spike. What you’ll notice is that fear spikes occur mostly in downtrends, and culminate around the lows. The tan regions show multiple fear spikes occurring while the market is in an uptrend (2013, 2017, 2022). Each instance prior saw higher stock prices before a correction began.

Rarely do we see the market rewarding a crowded trade. Even when that trade makes the most sense. In order for a setup to go lower, we need to see sentiment reset. There is a high level of bearish bets right now, and these will likely need to unwind if we are going lower.

Interestingly, this lines up with what we have been saying for the last 3 weeks here, which is summarized in the most recent YouTube video below.

We have been raising large sums of cash throughout late November/early December in preparation for a volatile month. The volatility has only increased the number of bearish bets in the market as many stocks approach oversold conditions again. We believe that the market is setting up for another rally, which should last through early January.

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Whether we drop to new lows, or continue higher is yet to be seen. There are some markets in the US and abroad that have clean setups to new highs, which we’ve discussed here and here.  This would certainly be the contrarian perspective going into 2023, which is worth acknowledging. However, the global central banks went on an aggressive rate hiking campaign while shifting global trade dynamics are exacerbating inflationary pressures worldwide. This is happening while we are experiencing drastic decelerations in key tech sectors, which we discussed here. So, we are not married to a thesis, and are ready to shift in either direction once we get clear signals. We believe the biggest risk that investors face going into 2023 is thinking they know what will happen and not considering there is more than one possibility.

In conclusion, we believe there will be a Christmas Rally of sorts as the probability favors a move higher as we enter 2023 into the first couple of weeks of January. Both the market internals and sentiment have reached a level of bearishness that rarely leads to a prolonged drop. Look for this to reset before we go lower.

Regarding the long-term narrative, instead of leaning into a thesis, we prefer to let price action determine whether we hedge, or leverage our portfolio to the long side. This neutral stance has been rewarding for us as an all-tech portfolio. As of now, we are leading our all-tech peers and our audited results will be out in Q1 of 2023.

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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