Blogs -The Risk is Higher in the Market than it Feels

The Risk is Higher in the Market than it Feels

May 02, 2024


Knox Ridley

Portfolio Manager

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.

sp500 & mag7 chart analysis

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.

naaim & aaii investor sentiment

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.

sp500 chart analysis

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.

sp500 daily chart

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.

sp500 weekly chart analysis

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.

meta stock chart analysis

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.

The choppy consolidation after their Q4 results resembles a distribution top, which is where we see large institutional trades sell to an eager retail crowd. This was confirmed by the recent earnings report resulting in a large gap below the major trend line, which happened on heavy volume.

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Also, it’s worth noting the importance of gaps within an uptrend. These are literal gaps between the closing price and opening price, usually on heavy volume. They are key markers within a trend and tend to unfold in 3s: the breakaway gap is the 1st indication that a new uptrend has started, the runaway gap typically happens around the halfway point of the larger uptrend, and the final gap is the exhaustion gap, which tends to happen around the end of the trend. So far, this is exactly what we have seen, and was confirmed with the recent selling gap, which tends to signal a trend reversal.

meta stock chart

Source: I/O Fund

Amazon is another Mag 7 stock that is signaling a larger pullback is likely underway. Note the clear 5 wave uptrend off the 2022 low. Just like in Meta, the final 5th wave in Amazon was happening on weaker momentum, signaling that the strength in the uptrend was fading.

amazon stock chart analysis

Source: I/O Fund

What follows a five wave uptrend is a correction of the same degree. We are unfortunately dealing with a 1.5 year five wave uptrend. If this is what is playing out, this means we should see a multi-month correction, which should retrace most of the final push off the October 2023 low.

Amazon’s pattern is an ending diagonal, which is another piece of evidence supporting the final push will be a top for Amazon. As stated earlier, these patterns are tight, with choppy moves higher that trace a trend channel. They happen as the final 5th wave of a move, and when they end, we tend to see a swift drop back to the start of the pattern.

amazon chart analysis

Source: I/O Fund

The above ending diagonal pattern took 21 days to complete and only 6 days to retrace the entire pattern, which further confirms that this is likely an ending diagonal. Since these patterns only occur at the end of a move, we are likely setting up for more volatility into the coming weeks – months. If the current bounce can break above $190, then we could see an extension of this final 5th wave higher before rolling over.

A Note on Google

The divergences discussed in our last report regarding the Magnificent 7 was the clearest signal that a correction was building. Google was the 3rd of the seven to start making lower highs against the market pushing higher. This was the right call, as the market is now in a clear correction.

However, GOOGL recently pushed to new highs in their last earnings report. I believe this push was the final 5th wave within a pattern called an expanding diagonal. This patter is common in 5th waves, and also lines up with the rest of the market. Note below how the  final 5 waves each moved respected the expanding trend channel. If GOOGL closes the recent gap around $157, this will be the first signal that this pattern is in play.

alphabet stock chart analysis

Source: I/O Fund

Regardless, future market leaders will emerge from volatility. They will go down less than the broad market and tend to bottom before the broad market. It is too soon to tell, but this move in GOOGL is one we are watching as a potential market leader when this volatility ends. 


The last six months have been a historic, and nearly vertical move higher. From November 2023 to March 2024, we have not seen even a shallow pullback --- which is uncommon. With that came a level of exuberance that has not been recorded before in the AAII Investor Sentiment Survey. The level of greed in the market has not only created extreme valuations with stocks, but it created a tight rope that the broad market had to walk in order to keep pushing higher.

Once the recent volatility broke below the 5080 – 5055 support zone, the odds tilted in favor of a top being in. As long as we hold 4950 and break back above the 5225 region, we can extend this move higher. However, if 4950 breaks, we will have full confirmation that a top is in as the next move tests the 4800 – 4600 region. Because of this, we believe this market warrants caution.

If you own Tech stocks or are looking to own Tech stocks, consider joining us for our next broad market webinar. Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, manage risk, as well as revealing our various long-term game plans regarding stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.

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