Markets have been volatile following the news of the omicron variant. This is consistent with our expectation that markets would trade in a choppy and headline-driven fashion near term. Investors are awaiting clarity on the variant’s transmissibility, severity, and vaccine responsiveness. Yet, this is set to take more time. This creates uncertainty. Uncertainty leads to many investors fearing the worst-case outcome.
While uncertainty is uncomfortable, we view it as a positive that investor sentiment has been sharply reset. Indeed, markets are all about how data comes in relative to expectations. And, while most investors are focused primarily on the downside of the variant, our work suggests markets are set up for a sharp snapback if it proves less problematic than current fears.
Indeed, the S&P 500 has rebounded from the initial support levels we outlined, and are responding favorably to an oversold condition.
We still see further upside over the next 12 months, even while expecting market volatility to remain elevated near term. Recession risk still appears low, and corporate profits should remain resilient, as evidenced by the past two years.
In today’s note, we highlight several charts supporting our view:
- Markets have responded to the first level of support.
- The percentage of stocks in the S&P 500 that trade above their 50-day moving average moved below 30%. This is the most oversold condition since late September, prior to the October rally, and at an area where the market has tended to rebound.
- Over the past 15 days, we have seen the recommended equity allocation of newsletter-writers drop sharply from 73% to just 18%, according to the Hulbert Sentiment Index. This reflects a sharp reset in investor sentiment.
- Likewise, the percentage of retail investors with a bullish view has dropped to just 27% versus 48% a few weeks ago, according to the latest survey from the American Association of Individual Investors (AAII). Conversely, the percentage of bearish investors jumped to the highest level in more than a year.
- Also, when we look at the previous instances when the Volatility Index (VIX), which is also known as the fear index, spiked more than 40% in one day, as happened last Friday, stocks were higher 18 out of 19 times a year later, with an average gain of 20%.
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