Watch for Deviation Between What Should Happen vs What Does Happen

I have been going through sentiment indicators trying to get a read on the market. My view is that the bottom is forming. It could already be formed or the low could be incoming. The low could be as much as 20 percent lower from here, but a low also forms in time. A plunge is going to be swift, as in whatever drop unfolds will complete quickly and the reversal will be swift.

There is no reason to be bullish here, other than almost every bear says that very thing, "There's no reason to be bullish here." A bear market rally doesn't happen when everyone is bearish, it happens when everyone who gets bearish in round one has positioned themselves for more bearishness. Think of it like a market top in reverse. The bear market begins when there's no one left to sell to because everyone who wants to buy has bought. Similarly, a rally starts from selling exhaustion.

Here's PMO (black indicator below). It has fallen to a level last seen in the middle of the worst phase of 2008, but before that, at the Bear Stearns low. When the market hit that point, the bulls thought the worst was over. Financial firms started layoffs, yet most money managers probably hadn't sold much at that point. The only reason I'm not more confident a low is in, is because there hasn't been a "Bear Stearns" culmination panic. VIX doesn't have to spike though. VIX was higher in January 2008 than in March 2008 when Bear Stearns went bust.

Here is a zoom in:

Here's how it looked in 2008:

Not as clean a setup as in 2008, but maybe because it's still a little early.

Earnings season should be terrible. Guidance should be horrible. High yield spreads are blowing out. Everything says sell here except technical and sentiment indicators, but those could be fakeouts. Leaving macro signals such as crude oil aside, I'm watching for a divergence between news and price in the stock market. Some type of negative news, probably earnings related, that "lifts" stock prices. That will be the tell that bears are too pessimistic. News isn't bad enough to induce more selling from the bulls.

Think of bulls as belonging to different groups: the skittish, the observant, the confident, the clueless/impervious. The skittish have almost all sold to this point. The observant are watching, but not convinced of a bear market yet. They will fuel the main wave of selling that starts later. Another rally will unfold when they're done. The confident will eventually lose their confidence and sell in the last wave near the lows. The final group will never sell.

Here's the S&P 500 (SPY) in 2000. Two 25 percent rallies between the three waves of selling. A third rally depending on how you view the double-bottom in July and October 2002.

Here is 2008. The first rally, Bear Stearns was only 15 percent, but a similar rally from the June low takes SPX to about 4200.

The first big rally of this bear market is coming soon, if it hasn't already begun.