Sentiment Is Extremely Bearish, Setting Up The Stock Market For A Nice Rally

For the first day in 2 weeks, the U.S. stock market did not selloff in the final hour of trading yesterday.

Let’s analyze the stock market’s price action by objectively quantifying technical analysis. For the sake of reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

*Probability ? certainty. But if you consistently trade against probability, then you will underperform in the long run.

Sentiment is at an extreme

Sentiment for the U.S. stock market is very bearish right now. The Total Put/Call Ratio’s 15 day moving average (3 weeks) is now at 16.

Historically, this has been a nice setup for a rally over the next 2-3 months for the U.S. stock market.

Here’s what happens (historically) when the Put/Call Ratio’s 3 week average exceeds 1.15 (first case in 1 month)

*Data from 1995 – present

As you can see, the stock market tends to go up 2-3 months later, even during the 2008 mega-crash.

Breadth is very weak

The U.S. stock market’s breadth is very weak. This is seen through the NASDAQ’s McClellan Summation Index, which is a NASDAQ breadth indicator.

*Data from 1998 – present

As you can see, the NASDAQ’s McClellan Summation Index has been below -1000 for 2 days in a row.

Here’s what happens next to the NASDAQ (historically) when the McClellation Summation Index fell below -1000 for 2 consecutive days (first case in 1 month)

As you can see, the NASDAQ tends to rally over the next 1 week. The 1 really bearish case was October 2008, when the stock market had already crashed more than -30%.

Stocks tanked while VIX remaind subdued

What’s interesting about the recent correction is that while the stock market fell almost -10% (using daily CLOSE), VIX has remained relatively subdued. These 10% declines usually see VIX rise above 30.