Market Sentiment Shifts as a Historically Positive Pattern Emerges

Key points:

• Investors have entered the "Returning Confidence" phase of the Sentiment Cycle.

• This has triggered a signal with an attractive historical risk-reward profile.

• Following the signal, small-caps and cyclical sectors have typically outperformed.

The "Returning Confidence" Phase is Now Officially Confirmed

A widely used framework for gauging market psychology draws from the Sentiment Cycle popularized by Justin Mamis in his 1999 book, The Nature of Risk. This cycle has four core phases: Enthusiasm, Panic, Discouragement, and Returning Confidence.

The "Returning Confidence" phase is defined by three key traits: choppy yet sustained stock price gains, broadening market participation (especially among small-cap stocks), and easing credit conditions. Critically, this phase often signifies the transition from a market bottom to a more durable uptrend.

To validate when this phase is likely in effect, we tracked every instance where the correlation to "Returning Confidence" rose from below 0 to above the notable threshold of +0.7 within a 126-day window. Since 1933, this signal has triggered 31 times-with the most recent occurrence last week, on September 26, 2025.

Below is a summary of the S&P 500's performance following each of these signals since 1933:

Over the medium-to-long term, the post-signal outlook is historically positive. One year after a trigger, the S&P 500 not only rises 87% of the time but also delivers a solid median return of 12.2%. The risk-reward dynamic is even also noteworthy: the average maximum gain over the next year (+14.7%) is nearly 4x the average maximum loss (-3.9%).

While short-term choppiness is common in the first 2-3 months (reflected in a 61% win rate for the 3-month horizon), the long-term historical pattern suggests: these signals have often marked favorable entry points for equity investors.Related Backtest Click Here.

Validation in Modern Markets

To confirm the signal's relevance in today's market, we isolated data from the past 30 years-and the results are also compelling.

Over this period, the signal has triggered 9 times. While short-term volatility (2-3 months) persists, the medium-to-long-term performance has been positive in all past instances.

Notably, in the past 30 years, the S&P 500 has delivered positive returns every single time 6 and 12 months after a signal. This suggests the signal's predictive power has not faded; if anything, its reliability for medium-term gains has remained strong in modern markets.Related Backtest Click Here.

A Significant "Risk-On" Signal

Historical data shows investors consistently shift toward riskier assets after these signals.

Among major indexes, Small-cap stocks (Russell 2000) stand out: they post a median return of +9.0% 6 months after a trigger and a strong +14.4% one year later. Their win rates are equally impressive-100% at the 6-month mark and 93% at the 1-year mark.

This "risk-on" bias extends to sectors: the Communication Services and Energy sectors have delivered positive returns in all past instances 1-6 months post-signal, while the Industrials sector also performs strongly. In contrast, defensive sectors (e.g., Consumer Staples) and interest rate-sensitive sectors (e.g., Financials) tend to lag significantly in the months following a trigger.

What the research tells us...

The Sentiment Cycle provides a valuable framework for understanding the market's emotional state. When the correlation to "Returning Confidence" reaches this level of strength, it suggests the market's bottoming process may be well-advanced-and that a more durable uptrend could be forming.

While history never guarantees future results, the evidence here is notable: the signal that just triggered has often preceded periods of strong stock market gains. For the medium-to-long term, the odds would now appear to favor the bulls-with historical leadership from cyclical and risk-on assets like Small Caps.