Our last broad market report entitled “The Magnificent 7 are Falling Like Dominoes; Only 3 Remain” warned investors that risk was building in the markets. Specifically, it was discussed that the current market leaders, deemed the indestructible “Magnificent 7,” were putting in tops one leader at a time. First Tesla put in a top, then Apple, Google and Microsoft, all started making lower highs, while the broad market kept trending higher. As we stated in that report, “When these cycle leaders start underperforming, it usually marks the start of a trend change.”
Just days later, the AI powerhouse and market leader, Nvidia, put in a top on March 8th, while the S&P 500 continued higher. This left only Amazon and Meta from the original Magnificent 7 pushing higher with the S&P 500.
Source: I/O Fund
Sure enough, on March 28th, the S&P 500 followed the Mag 7 down, as we are now seeing volatility pick up for the first time in over 5 months. Now, investors are wondering if this is a buying opportunity in a larger uptrend or the start of something more severe?
In this report, we will show that the sentiment readings over the last several months suggest investors should be cautious. This is backed up by our broad market analysis, which indicates that risk is more elevated than most investors may think. This doesn’t mean we can’t push marginally higher. Instead, it is suggesting that the downside is greater than any additional upside. Interestingly, the last two standing from the Mag 7, Meta and Amazon, appear to be giving the strongest clues that we could see more volatility over the coming weeks to months.
Historic Sentiment
The below graph measures the percentile rankings of the weekly AAII Investor Sentiment Survey going back to 1987. The survey simply asks a group of investors where they believe the market will be going over the next 6 months.
Based on the answers, it provides a percentage of those surveyed that have a bullish or bearish outlook about the markets. It then measures the spread between the bulls and bears to provide a comprehensive reading regarding market sentiment.
It is best used as a contrarian indicator. The idea is that the more extreme the readings become, the closer we are to trend change.
Source: I/O Fund
Based on recent volatility, the participants are starting to get more concerned about the future markets, as you can see the increased number of bears over the last 2 weeks. However, look at the highlighted period November 2023 – April 2024. The spread between the bulls vs. the bears during this 22 week period stayed in the 70th percentile of all bullish readings going back to 1987. Out of these 22 weeks, 13 weeks were in the 90th percentile of all bullish readings.
We have not seen a consistent streak of exuberance that lasted this long within the history of this survey. The closest period was December of 1999 – February of 2000, where we had 18 weeks where the spread between bulls and bears were in the 70th percentile, with 14 of these weeks above the 90% threshold.
This level of exuberance warrants cation based on historic readings. Sentiment is a powerful measurement, as investing is not a zero-sum game. For every buyer, there must be a seller, and when everyone piles into the same side of a trade, willing to pay any price to get more gains, there is only one way for the market to go.
Broad Market
The extreme sentiment readings are coinciding with a potential top, of sorts, unfolding in the broader market. The S&P 500 broke out to new all-time highs earlier this year, which means that the 2022 bear market was just a deep correction within a larger uptrend.
The pattern that has unfolded in this new bull cycle has taken the shape of a common technical pattern called an ending diagonal. This is a choppy, and narrow pattern that traces within a channel and always consists of five waves. Most importantly, these patterns only show up in the final 5th wave, which is the end of a trend.
Source: I/O Fund
Note how we are very far along in the 5th wave pattern, and touching the lower boundary of our 5th wave topping zone. We are pushing higher on fading momentum, which is a typical sign that we see in the final 5th wave of an uptrend.
The breakdown, so far, has made a push into the upper regions of the 5th wave target box less likely. However, until we break below 4950, there is a chance we could push higher before rolling over. It would require the market not making a new low, and then breaking out above the 5225 level.
Source: I/O Fund
Based on the current price information, I believe we are still in a downtrend, which is bets shown in the chart below. The below path in blue shows an overlapping bounce off the recent lows. We can still push higher from here, but as long as we do not see a vertical breakout above 5225, I expect this bounce to fail as we push lower. A break below 5015 will be the first warning, and the final support will be 4950. If we do break below 4950, what my particular style of analysis tells me, is that there is not a path to new highs within the ending diagonal pattern that started in October of 2022. We will need to see a sizable correction, at best, in order to start a new pattern pointing higher. For this reason, it is likely that we see volatility pick up.
Source: I/O Fund
The Mag 2
The final two Mag 7 stocks appear to be supporting the conclusion that a top is in place. Meta, for example, has been tracing the final 5th wave off the November 2022 low. Note how this final move higher has happened on lower momentum. This is common in the final 5th wave of a trend.
Source: I/O Fund
There is a low probability that we hold $406 and turn higher for one more high. However, I find this to be unlikely based on the additional clues within the chart.
