Today’s Rally Could Kickstart a Big Move

54% of U.S. investors are bearish … the emotional conditions that usually accompany a market top … six reasons why this bull could still have legs


The market has been under pressure for weeks. And the last few trading sessions have seen nerve-rattling volatility.

But as I write Thursday afternoon, we’re enjoying a strong rally.

What’s going on here?

Is today’s strength evidence that we’re clawing out of a mini-correction? Or is this just early turbulence preceding a long-awaited monster crash?

Well, for context, we’ve been in a stealth correction for weeks.

My colleague, Luis Hernandez, sent me this tweet yesterday. It reveals the percent of index participants that are down at least 10% from their year-to-date highs.

For the S&P, Nasdaq, and Russell 2000, respectively, those percentages are 91%, 90%, and 98%.

Chart showing the 90%+ of index constituents already down 10% or more from highs
Source: Liz Ann Sonders

So, is this evidence that the much-anticipated, great meltdown has finally arrived (despite today’s rally)?

Perhaps. No one has as crystal ball.

But I suspect not.

I think the strength we’re seeing today is a prelude to a broader market recovery as we move deeper into the fall.

***Earlier this year, investors were downright euphoric

You remember the GameStop and AMC spikes that had investors giddy, making huge returns in meme stocks literally overnight.

Meanwhile, despite some volatility, the broader market continued grinding higher, week after week, month after month.

On the whole, I’d guess you were feeling pretty good about your portfolio and the market in general.

How has the average investor feeling been about the market in recent weeks?


Yesterday, we learned that a new survey from Allianz Life shows that 54% of American investors are worried that a big market crash is on the horizon.

So, what are they doing about it?

From BusinessInsider:

But now more than two-thirds said they are protecting their money from losses by keeping some of it out of the market.

In particular, worries about the coronavirus and inflation gripped most investors.

Meanwhile, CNN’s Fear & Greed Index is showing that “extreme fear” is driving the market right now.

CNN's Fear & Greed Index showing that Extreme Fear is driving today's market

It’s not just retail investors.

Last month, we learned that professional money managers are increasingly bearish on the economy.

From MarketWatch:

In September, the net percentage who say the global economy will improve over the next 12 months fell to 13%, down 14 percentage points from August the lowest since April 2020, and down from the 91% peak in March 2021.

Similarly, expectations of rising profits have dropped to a net 12%, a 29 percentage point nosedive, and the worst reading since May 2020.

These managers have also slightly increased their cash positions.

***Historically, this isn’t what a market-top feels like

Whether on a stock-specific basis, or for markets in general, “tops” tend to form when investors are wildly-confident, bullish, and greedy. Meanwhile, “bottoms” are typically carved out when investors are despairing and hopeless.

For example, there’s former Federal Reserve Chairman, Alan Greenspan, coining the phrase “irrational exuberance” to describe investor sentiment during the 90s Dot-Com run-up.

This paralleled the classic magazine cover from Newsweek in 1999, capturing the greed and “fear-of-missing-out” that accompanied the era (published just months before the markets collapsed).

Classic Newsweek cover showing the lament of '99, that everyone else is getting rich
Source: Newsweek

Fear-of-missing-out is not driving today’s market. We’re not seeing the rampant speculation that began the year. Instead, we’re seeing abject fear.

As one illustration, Jon Wolfenbarger, former equity analyst at Allianz Global Investors, said that U.S. stocks may be “on the verge of starting the biggest bear market since the Great Depression.”

But with so many investors terrified, can we use that as a clue pointing toward more gains?

***The impact of emotion on market dynamics

Prior to joining InvestorPlace, I worked with a quant investor named Meb Faber, occasionally co-hosting a financial podcast with him.

One of our guests was Jason Goepfert, founder of the investing service, SentimenTrader. Jason studies the impact of human psychology on the financial markets, using a series of indicators to give him an idea about where the markets might be going next.

In preparing for our podcast with Jason, Meb and I had a discussion which delved into investor sentiment, fundamental analysis, and bear market crashes. In essence, we were wondering what’s the final prelude to a bear market?

My kneejerk answer was “extremely high stock valuations.”

But as we chatted, it became obvious that nosebleed valuations, in-and-of-themselves can’t be the answer. After all, if investor sentiment and momentum is wildly bullish, then the buying continues. What was “extremely high stock valuations” quickly becomes “absurd, laughable, egregiously-high stock valuations.”

So, investor sentiment trumps stock valuations.

This awareness focused Meb and me back to emotion, and we found ourselves wrestling with one fundamental question:

Is “irrational exuberance” a requirement for a bear market to strike?

The idea is that when investors are irrationally exuberant, that enthusiasm draws practically all investors off the sidelines and into the market. And when everyone is invested, and there’s no one left who’s willing to buy at nosebleed prices, that’s when the bubble bursts.

This is not where we are today.

***“Jeff, you fool, this isn’t where we are today because it’s where we were months ago. We’re now on the other side of the irrational exuberance phase, on the down-slope

That’s possible.

But when, exactly, was that irrational exuberance? In January, with GameStop?

That was a relatively small percentage of investors participating in that madness. Not the entire retail and professional investor base.

Was it later in the spring? With the SPAC boom and/or tech-frenzy?

Also, possible, but even then, were we seeing flat-out mania from the entire market? And tech is already down big from its top earlier in the year, courtesy of sector rotation.

The reality is that fear – not exuberance – has been taking over the collective investor psyche for months now.

Take this CNBC article from back in April:

The percentage of investors with $1 million or more in brokerage accounts they self-manage that sold out of market positions and went to cash in the second quarter more than doubled, from 7% to 16%, according to a new survey of wealthy investors from Morgan Stanley’s E-Trade Financial shared with CNBC.

Overall bullishness declined as well, with millionaire investors who say they are now bearish increasing by 6 percentage points, from 36% to 42%.

***Plus, let’s be diligent market historians before we write-off the end of this bull market

Last September, the S&P dropped 9.6% top-to-bottom before rallying to end the month…and then got smacked in the face with another 7.5% loss in October.

Compare that to today.

From early-September highs, the S&P is now down less just 2.5%. Its largest top-to-bottom decline was roughly 5.3%.

Chart of the S&P showing two big drops one year ago versus the relatively mild drop last month

If anything, we should be expecting more temporary weakness – not losing sleep over a 5% drop.

And don’t make the mistake of thinking that the fear this time around is different, or more substantiated.

Below, we revisit some headlines we featured in our 9/17/20 Digest. This was in the middle of the S&P cratering 9.6% last September…

Frightening headlines from one year ago when the market was weak

Anyone who sold thanks to these “expert” predictions last year missed out on 33% gains from QQQ (a proxy for “tech,” which took the biggest beating in the headlines above).

Plus, that 33% includes the recent drawdown. The gain was more than 40% before September.

***Why the market could easily continue climbing after we navigate today’s volatility

One, because we’re already in the middle of a stealth correction, as the tweet at the top of this Digest illustrates.

At some point, many investors will say “that’s it – buying opportunity.” Today might be that day (though I’d expect the volatility to hang around a bit longer).

Two, because not all investors are “all in” as evidenced by the fear, recent selling, and growing cash-positions.

Three, because 3rd quarter earnings begin in a couple weeks and are likely to bring back some optimism.

Four, because despite recent hiccups, our politicians will find some way to pass another multi-trillion-dollar piece of legislation that bazookas the economy with even more cash, inflating the investment markets even further.

Five, because “transitory” inflation continues to erode those “safe” dollars that investors have pulled out of the market. You can’t reach your financial goals when a huge chunk of your net worth is losing, call it, 5% of purchasing power per year. The rationale for the TINA trade remains (There INAlternative to stocks).

Six, because despite all the hand-wringing, higher rates remain a long way off.

So, coming full-circle, what do we make of the multi-week weakness? Is it a prelude to a crash?

No one knows, and that’s certainly possible. But for now, there are plenty of reasons to believe the markets are headed north. This bull isn’t ready to die just yet.

We’ll keep you up to speed here in the Digest.

Have a good evening,

Jeff Remsburg

Article printed from InvestorPlace Media,

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