Santoli: The steadiness of Wall Street’s ‘fear gauge’ – even in this rout – confounds bulls and bears

Published Thu, May 19 20221:24 PM EDTUpdated Thu, May 19 20222:54 PM EDT

This is the daily notebook of Mike Santoli, CNBC's senior markets commentator, with ideas about trends, stocks and market statistics. Twitchy, tentative action just above last week's intraday lows – also a 14-month low. These are typical tactical fog-of-war conditions. Everyone knows the overall market trend is ugly. Everyone sees the oversold extremes building. Almost no one thinks the ultimate low is in, but a huge amount of discretionary selling has already occurred. The wait for further "extreme extremes" to emerge in a headlong downside panic can sometimes be interrupted by quicksilver waves of buying. An unstable tape for sure, the frequency of 1% daily moves getting extreme and the blowups in purported safer stocks causing everyone to focus on risk management and stress-test portfolios for more of the same. It generally computes to professional investors putting less capital into the market, being quicker to sell than to buy, and the indexes moving far and fast to hunt for buyers and sellers with conviction. Treacherous, but it's part of the reckoning process and not in itself a longer-term negative. The big picture hasn't changed all that much. Almost two weeks ago with the S & P 500 near 4,100, I started focusing on the 3,800-3,900 area where a cluster of fundamental, technical and historical-pattern downside targets were clustered. The positioning algorithms are aware of all this, and so levels are being tested and retested. Will it hold? Just a pause? Another doomed modest bounce? More distant and recently more popular downside targets below this area are near 3,400-3,500, eventually, which would wipe out half the post-March 2020 rally and near the peak index levels from before the Covid pandemic . It's not bearish to have new, lower downside targets gaining adherents, in some sense. Again, citing extreme sentiment/positioning indicators has not been a help as sellers have remained in control, the threshold for viewing such things as contrarian buy signals is higher in a steep downtrend. Still, the National Association of Active Investment Managers professional advisors' equity exposure index has sunk to yet another severe low for this pullback. At some point it might matter. Most of the market story this year has not only been consistent but expected: Valuation compression as Federal Reserve tightens/profit growth slows; late-cycle increase in volatility; narrow path to a soft landing (threats to growth and from the Fed on either side); bumpy transition from goods to services consumption. The fact that this was all in motion as valuations sat near historic highs, investors were overexposed to equities, crypto was rolling hard and a war/domestic economic friction waged has made it feel more extraordinary. Exacerbating, not causal, factors. The pluses in the recent action: The S & P 500 has closed a gap left by last Friday's pop. The selling is reaching the safer hiding places such as staples and AAPL , as early bear victims – semiconductors and ARKK – try to base. Sentiment has consistently been pretty negative. Options expiration Friday and the week after has often proved an inflection point (March 2020, December 2018). The bond market has a bid, showing economic-growth anxiety but also a cooling of inflation/Fed fears. The WMT/TGT margin woes mean middlemen are absorbing incremental cost pressures rather than consumers. The leading indicators of recession are not yet flashing bright (yield curve, leading indicators; housing, corporate profits, jobless claims). Working against all this is the fact that previous S & P lows after deep corrections in the past decade have occurred closer to 14 times forward earnings than the current 16-ish. And yes, we could see profit estimates erode a bit from here. Much repair, technically, will need to occur even if the indexes get some traction soon. Market breadth is solid, 50% to 60% upside volume, but that can shift quickly if we hit an air pocket this afternoon. VIX at 30 continues to confound observers and satisfy no one. Bulls would love to see it collapse toward 20 as a bounce emerges. Bears complain it needs to rip above 40 to reflect a proper flush of fear, likely with the indexes shuttling lower. Seems the Street is very hedged up, outright selling rather than buying protection and the downtrend has been rather steady and orderly, not jagged and driven by headlines. Is this a good or a bad thing?