Markets were roiled by the Facebook earnings miss this week. The stock declined around 26% yesterday in response which was the largest single-day decline of market-cap ever. Despite the market’s harsh reaction to that big miss, we still see the most likely outcome as a violent upside rally in February 2022. Remember we went over three reasons why we say an upside rally is likely earlier this week.
- Retail investors raised cash at the fastest pace since before the pandemic –> contrarian buy signal
- S&P 500 daily RSI fell to 26, the lowest reading since March 2020 –> oversold = buy signal
- Retail sentiment (AAII) fell to the worst reading since 2013 –> contrarian buy signal
One of the reasons we feel confident in using retail sentiment as a contrarian signal is because retail investors have now come to comprise such a large portion of markets. Retail investors have become about 40% of the market and right now they are “bear-market” bearish. Thus, we see nearly half the market being structurally bearish as a contrarian bullish signal. We also are seeing cases rapidly decline in the places where Omicron first surfaced in the US, like New York.
Institutional accounts and retail accounts have been moving in opposite directions cash-wise. While retail investors have been selling and moving to cash, institutional accounts have been buying. We also saw relative strength drop to the lowest level since March 2020. We think there are still multiple supports in place for our assertion that the market will likely have a ‘V-shaped rally in February.
The thing is, when sentiment has dropped to the extremely bearish levels that have been observed, the forward 3M, 6M, and 12M returns are positive. Six out of the six most recent times when sentiment dropped to levels similar to those being seen now, the returns have been positive. As we flagged last week, the AAII (American Association of Individual Investors) retail sentiment survey, shows investors are extremely bearish:
- The net % bulls less % bears is -29.8
- this is the lowest reading since 2013
- the returns after the last times sentiment was similar is shown to the left.
We like this series because it is one of the longest-running series on investor sentiment (since 1987). And moreover, at the extremes, we view this as a contrarian indicator.
Earnings season is also showing a lot of strength in the market despite the market’s “fire, ready aim” disposition. To me, when markets are this fragile and nervous, the probability of positive surprise is higher. We see this as the case yesterday given the still strong fundamentals and given the retreat in COVID-19 cases.Despite the high-profile earnings misses, trends are largely positive and show that operating leverage is still in place. Sales and EPS growth show this is the case. Energy has been the leading sector with sales growing at a “Wow” rate of 81.8% YoY.
After waterfall decline, history says +7%/ +13% next 3M/ 6M
The S&P 500 posted a waterfall decline of 11% peak to trough over 14 days in January. On a closing basis, it would be a ~9% decline. While many things seem common in this pandemic era, a fall of this velocity is actually rare. Furthermore, it is kind of oxymoronic to say we are at the apex of a bubble when sentiment is at anomalously bearish levels. The latest fall showed just how fragile confidence was.
In fact, in the past 10 years, this velocity of fall has only happened five prior times. All five times marked the end of the sell-off, rather than the beginning of one. In fact, the five precipitous falls all resulted in a subsequent fierce and violent rally. The bottom line is that there is a ton of bad news already priced in. TINA is also more alive than ever. Despite the prominence of equities in the headlines, some may forget that half of American household assets are still invested in debt. Ultimately, we see the possibility for more treachery ahead given the risks, but the implied forward returns based on similar sell-offs in the past make the risk/reward compelling both three and six months out.
Tireless Ken and the data science team compiled forward market returns, following 14D market declines. These are tiered below into deciles:
- the ~9% fall ranks as the “worst decile” since 1938
- the worse the 14D decline, the larger the bounce
- the relationship holds as we move down the deciles at the worst decile, forward 1M, 3M, and 6M returns are very strong
- forward 3M and 6M returns are 7.1% and 13.0%
- this implies S&P 500 > 4,850 before 1H2022
- hence, this reinforces our view that markets can stage a strong rally from Jan lows into Feb
- but we believe 1H2022 remains treacherous
Figure: Way forward ➜ What changes after COVID-19
Per Fundstrat
Figure: Fundstrat Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
