Andrew Kelly/Reuters
- A sustained stock market rally into 2023 will only happen if investor sentiment remains bearish, according to Ned Davis Research.
- Investor sentiment has hit bearish extremes in recent weeks as inflation and interest rate concerns linger.
- "Sentiment would need to remain subdued, providing a wall of worry for the market to climb," NDR said.
A rally in the stock market heading into 2023 won't be sustainable unless investor sentiment remains in bearish territory, according to a Thursday note from Ned Davis Research.
And so far, so good. NDR's proprietary trading sentiment composite remains in "extreme pessimism" territory, CNN's Fear and Greed Index is in "fear" territory, and AAII's weekly investor sentiment survey shows an overwhelming amount of bearish responses at nearly 60%.
That's all after the S&P 500 rallied 7% from its intra-year low following last week's release of the September CPI report. But the market has a long way to go before it reaches levels seen just two months ago, and if investors turn more optimistic too quickly, there's good chance it will be just another bear market bounce.
"Sentiment would need to remain subdued, providing a wall of worry for the market to climb...A quick jump from pessimism to optimism would signal the rally may have run its course," NDR said.
The market has some tailwinds ahead, according to the note, as the fourth quarter is the strongest of the year, on average. Additionally, favorable seasonals have been observed heading into and after a mid-term election.
"The fourth quarter of midterm years kicks off the best three-quarter stretch of the presidential cycle," NDR said.
But those often cited seasonal tailwinds are just tendencies. They're uncertain. "There are no guarantees in this business," NDR warned.
Rather than rely on seasonal tailwinds, investors should be more tuned into ongoing technical and sentiment indicators that would suggest whether a potential year-end rally has legs into 2023.
On the fundamental side, resilient earnings, easing inflation, and a less hawkish Fed would all be signals that the economy is geared up for a soft landing, "which has become the minority view on Wall Street," NDR said.
That means there's upside potential if anything goes right, as few are positioned for such a move. Most investors believe the Fed will continue with its outsized interest rate hikes until inflation cools, and that will lead to them "breaking something" that results in a hard economic landing.
"The market needs to see evidence the economy is cooling enough to bring down inflation, but not so much that it will lead to a sharp earnings drop and recession," NDR said.
And if it does see that evidence in the coming weeks and months, a sustained rally is possible heading into 2023 as long as the wall or worry remains among most investors.
"By definition, rallies bring some traders off the sidelines. The difference between short-term bounces and sustainable advances is that the latter includes a wall of worry that gradually pulls investors into the market," NDR said.
source https://markets.businessinsider.com/news/stocks/stock-market-outlook-bearish-investor-sentiment-to-sustain-2023-rally-2022-10