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Why the ‘pain trade’ explains the stock market’s continued rise despite bad news

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Confounded by a 2023 stock-market rally in defiance of rising geopolitical tensions, a mini banking crisis and widespread expectations of near-imminent recession?

You’re not alone — and that’s the point.

The stock market’s resilience so far in 2023 is an example of a well-worn but sometimes useful market concept known as the “pain trade.” Tom Essaye, founder of Sevens Report Research, defined it succinctly in a Tuesday note: “The goal of the market is to extract the most amount of pain from the greatest number of people.”

As he explained, that means when everyone is bearish, the pain trade will be for stocks to move higher. And when everyone is bullish, for stocks to move lower.

“As such, the pain trade has been higher for all of 2023 and that’s helping support stocks despite decidedly mixed fundamentals (and mixed is being generous),” he wrote.

Measures of investor sentiment help to tell the story.

A month ago, in the wake of the failures of Silicon Valley Bank and other regional lenders, the widely followed CNN Fear and Greed Index tumbled to 28, deep in the “fear” category and just shy of “extreme fear,” Essaye noted. He added that the AAII’s Bulls/Bears Sentiment Index dropped to -28%, a level so deep into negative territory it’s often described as a contrarian buy signal, while the Investors Intelligence Advisor Sentiment Survey fell to 12.5%, a level that signals caution.

“That wide expectation of looming calamity, and the fact that it hasn’t come to fruition yet, has been a material contributor to equity resilience, because it’s made the pain trade higher as investors waiting for a decline that never occurred, and who are now chasing stocks higher as they remain resilient,” Essaye wrote.

Indeed, the S&P 500 index
SPX,
+0.09%

was up 7.7% through Monday from its March 13 settlement, which marked its lowest close of last month just after SVB’s March 10 failure. The large-cap index is not far off its high of the year just shy of 4,200. The Dow Jones Industrial Average
DJIA,
-0.03%

is up 2% in April.

The mid-March chaos saw markets go “straight from banking crisis to recovery,” said Olivier d’Assier, head of applied research, Asia-Pacific, at Qontigo, a Deutsche Börse-owned global index provider, in a Tuesday note.

Investor sentiment, however, “took a detour, with fears of a banking crisis (unrealized losses, bank runs, insolvency, closures, tight liquidity), giving way to fears of an economic crisis (earnings drought, loan defaults, unemployment, debt burden, hard landing) first,” he wrote.

But the relentless rally is gaining some converts, and sentiment gauges are no longer deep in bearish territory. Sentiment is improving across markets, not just in the U.S.

“Investor sentiment has stopped falling and began to climb in all markets we follow, perhaps in a desperate attempt to bargain with the Rumpelstilskinesque of rising markets,” said d’Assier.

As for the sentiment measures highlighted by Essaye, they’ve all moved higher. The CNN Fear and Greed Index stood at 67 on Tuesday, back in “greed territory.” An AAII Bulls/Bears reading at -8.4% still signals a cautious attitude, but a more “neutral” stance, Essaye said, while a 24.4 reading on the Bulls/Bears ratio is closing in on the 30 level that tends to signal a pullback may be in the offing.

In other words, sentiment has seen a substantial improvement, though not to levels that indicate the pain trade is ready to flip toward falling stocks, Essaye said.

Meanwhile, earnings season is getting fully under way this week.

“For the next three weeks, Q1 2023 corporate earnings reports and, more importantly, forward guidance for the rest of the year, will help bridge the gap between the resilience of markets and the reticence of investors,” said Qontigo’s d’Assier.

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Jake

Jacob Keiter is a husband, a writer, a journalist, a musician, and a business owner. His journey to becoming a writer was one that was paved with challenges, but ultimately led him to find his true calling. Jacob's early years were marked by a strong desire for creative expression. He was always drawn to music, and in his youth, he played in several bands, chasing the elusive promise of fame and success. However, despite his best efforts, Jacob struggled to find the recognition he craved. It wasn't until he hit a low point in his life that Jacob discovered his love for writing. He turned to writing as a form of therapy during a particularly difficult time, and found that it not only helped him to cope with his struggles, but also allowed him to express himself in a way that he had never been able to before. Jacob's writing skills quickly caught the attention of others, and he soon found himself working as a journalist for The Sun out of Hummelstown. From there, he went on to contribute to a variety of publications, including the American Bee Journal and Referee Magazine. Jacob's writing style is reflective of traditional journalism, but he also infuses his work with a unique voice that sets him apart from others in his field. Despite his success as a writer, Jacob also owns another business, JJ Auto & Home, which specializes in cleaning. Jacob's commitment to excellence is evident in all of his endeavors, whether it be in his writing or in his business ventures. Today, Jacob is the author of two books and continues to inspire others through his writing. His journey to becoming a writer serves as a reminder that sometimes our darkest moments can lead us to our greatest achievements.

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