Sentiment and technical measures show the bulls have been largely washed out. Stock market bulls have become extremely scarce. Based on two popular investor surveys (American Association of Individual Investors [AAII] and Investors Intelligence), bulls are as rare as they were at the March 2009 lows. Extreme levels of pessimism have historically provided accurate signals of market bottoms. The VIX measure of stock market volatility is calmer than we would expect, suggesting perhaps more volatility is needed to wash out more bulls; however, we could also interpret this to mean that markets were already positioned defensively coming into the year. Sentiment in the options market is similarly negative compared with levels at these prior major lows.
Fundamental picture offers some encouraging signs. Fundamentally, the current economic environment compares favorably to the last three major lows. Although this economic expansion has been lackluster, we continue to forecast 2.5% gross domestic product (GDP) growth in 2016. Leading indicators are supportive, job gains have been steady, and the service economy remains healthy (case in point: Friday’s strong January retail sales report, pushing total sales to an all-time high). All of this suggests, in our opinion, that the U.S. economy should avoid recession, and hopefully, help the S&P 500 avoid a bear market. The lack of earnings growth is concerning, as is the related softness in the Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI). These indicators are at levels consistent with prior bear market lows and mild recessions, and also suggest stocks may have a bit more downside.
Putting this all together, stocks may have some more downside; but if so, we see perhaps a further decline of 5% rather than 10%. That said, we cannot completely discount the possibility that the S&P 500 finds an eventual intermediate-term bottom near 1820 depending on catalysts that may emerge.