Watching the Turn, With Eyes on the Lines

Thoughts on the Market

Seventy-seven may be a lucky number in casinos — but luck hasn’t shown up in the market, where the S&P 500 has been flat for 77 trading days.

Like we noted last week, this prolonged consolidation within a longer-term uptrend is beginning to wear on investor sentiment. Beneath the surface, this choppy, rotational correction has driven one of the largest institutional equity outflows in nearly two decades. At the same time, hedge funds have also turned more defensive, unloading US equities at the fastest pace since March of last year.

The result: bears now outnumber bulls in the AAII Sentiment Survey for the first time in 12 weeks — mirroring the increasingly cautious positioning among active investment managers.

Our own Risk Model has reflected this deterioration in risk appetite throughout the corrective phase — flipping to risk-off on February 4 and remaining there ever since.

That caution is understandable. Most investors are hesitant to lean into risk when volatility sits in a range historically favored by bears. But last Friday’s rebound pushed the VIX back below its 10-day moving average and under 20 — a shift that, if sustained, could help reignite upside momentum.

The key question now is whether that improvement can hold, even with a fully loaded aircraft carrier and its squadron heading to the Middle East.

But here’s the thing, we actually like what we’re seeing. Sentiment has gone sour, investors have de-grossed, and US equities have become the most out-of-favor among global investors since 2020 — and honestly, that’s not a bad thing. It tells us a lot of risk has already come out of the market, which is usually what you need to start forming a bottom.

Having said that, we don’t think this needs a big flush to be over. This hasn’t been a broad market pullback but a rotational correction, with the pain already showing up where it mattered most, especially Software.

At this point, it’s worth remembering that markets don’t only correct by going down; sometimes they just go sideways. That’s what the broader indexes have been doing for the past four months.

A time-based correction that has done exactly what it’s supposed to do — make investors uncomfortable and second-guess their exposure!

Even though the S&P 500 is flat since late October, it’s actually about 7% cheaper now, because forward earnings have kept moving higher (from $298 to $320).