Inside Markets — Reflex Rally?

Yesterday’s single digit reading in the Daily Sentiment Index (DSI) on SPX futures was a clear sign of seller exhaustion and helps make the case for the ~5100 level to hold in the near-term. Any reflex rally from here (likely on favorable trade headlines) would run into resistance in the 5395-5450 range before a likely retest of current levels. We first need to see the pattern develop, but our sense is the SPX could form a more lasting bottom after that retest. A move lower from here (Lack of favorable trade headlines) would find strong technical support near 4590, which also matches the average peak-to-trough bear market decline of ~25%.

Favorable trade headlines from here would include a deferral of tariffs (go into effect tomorrow) for countries currently involved negotiations. In our view, this type of announcement would be enough for the ~400 point reflex rally mentioned above. Favorable headlines aren’t the ‘off ramp’ that markets are looking for, which likely include: 1) a fentanyl related deal that removes tariffs on Canada/Mexico and cuts 20% from China tariffs or; 2) the framework of a deal with a G7 country. While less likely, other off ramps include a veto proof bill for Congress to reassert control over tariffs or legal challenges that block current tariff policy. The tariff offramp scenario would likely take the SPY back through its 52-week VWAP at ~5500, which has acted as a bullish/bearish demarcation zone in the recent past.

There is no historical precedent for the current situation, which has everyone more focused on defining downside tail risk scenarios for the economy and markets. The attention on downside tail risks has bearish equity sentiment at 61.9, its second highest level in history. For context, bearish equity sentiment during the early months of Covid reached a peak of 52.7%, Equity sentiment is a contrarian indicator with extreme levels preceding key market turning points by a matter of weeks. The record in bearish sentiment was 70.27 from the 3/5/09 survey with the SPX making a bottom the next day before returning +83% over the next 12 months.