Physics-Based Drivers
We identify five physics-based drivers that forecast periods of naturally occurring optimism and pessimism. These operate independently of economic and market factors but exert significant influence on investor behavior, especially during periods of stress. Convergence between MRI and their drivers is often an early sign of market vulnerability.
Gradually Changing Drivers:
- Mega Driver: The phases of an approximately 13-year Mega cycle have distinct biases based on an analysis of returns, volatility, and S&P 500 P/E ratios from 1940 through 2023. Within this very long-term context, the sentiment drivers and episodes on the following pages indicate important shifts in investor sentiment that create meaningful opportunities to avoid losses and enhance returns. Historical average weekly Sharpe Ratios for the US stock market are in parentheses.
Phase 1: Entrenched Aspirational Thinking (Optimism),
Tolerance for High Valuations (0.09)
Phase 2: Entrenched Aspirational Thinking (Optimism),
High Sensitivity to Valuations (0.11)
Phase 3: Entrenched Critical Thinking (Pessimism),
Low Market Volatility (0.04)
Phase 4: Entrenched Critical Thinking (Pessimism),
During High Market Volatility (0.05)
- Macro Driver (dashed light blue line): Forecasts multi-quarter trends in naturally occurring sentiment that affect the Macro MRI. Levels are normalized to range from 0 to 100.
- Micro Driver (dashed green): Forecasts multi-week trends in naturally occurring sentiment that influence the Micro MRI and short-term price changes. Levels are normalized to range from 0 to 100.
Abruptly Changing (Episodic) Drivers:
- Flash Driver (dashed yellow): Identifies times when gradual sentiment trends are disrupted, often causing sudden market movements. Strong correlations exist between this driver and multi-week price disruptions. Every four to 11 years, this driver indicates a period of strong investor optimism, which we call an Anxiety-Free Period (AFP). The last one was in 2017/8 and the next will begin in April 2026. See this link for more information about AFPs.
- Minor Flash Driver (dashed gold): Detects brief bursts of optimism or pessimism. While not statistically significant over multi-decade periods, this driver is often associated with abrupt price moves.
The episodic Flash Drivers tend to overwhelm Micro and Macro Drivers. The Mega Driver (not shown on page 2) sets an important sentiment context for the market. Forecasts appear to the right of the vertical dashed line. Regarding accuracy, the episodic flash drivers are more accurate than the gradually changing drivers, which can be off by +/- a few weeks.
