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Bearish sentiment key to sustaining rally in 2023

A sustained stock market rally in 2023 is impossible unless investor sentiment remains bearish, according to Ned Davis Research.

While the NDR market sentiment indicator remains in “extreme pessimism” territory, the CNN Fear and Greed Index remains in the “fear” zone, and the weekly AAII investor sentiment survey shows an overwhelming number (- almost 60%) of “bearish” responses.

At the same time, after the publication last week of the September report on the US consumer price index in the US, the benchmark S&P 500 rose by 7% compared to the annual minimum.

While excessive and hasty investor optimism could create the possibility of another recovery in a bear market, a quick jump from pessimism to optimism would mean the rally may have run its course.

Traditionally, the fourth quarter is the strongest of the year in terms of corporate earnings in the US, and there have always been favorable results leading up to and after the midterm elections. However, NDR does not provide clearer guarantees.

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All of the signals could also point to a soft landing: solid earnings, declining inflation, and a looser Fed policy, so investors should be on the lookout for current technical and sentiment indicators that suggest whether a potential year-end rally will take place in 2023.

So far, opinion on Wall Street is that a hard landing is unavoidable as the Fed will continue to hike interest rates sharply until inflation subsides.

“The market needs to see evidence that the economy is slowing down enough to reduce inflation, but not so much that it leads to a sharp drop in income and a recession,” the NDR report says.

And if such evidence appears in the coming weeks and months, then a sustainable rally in 2023 is possible.

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