Will This Rally Last?

Will This Rally Last?

 

Will This Rally Last?


How long is the rally going to last ?

Just look at the data. 

Last week Dynamic Wealth Research published an article on extreme investor pessimism

The research cited a survey from the American Association of Individual Investors (AAII). 

The survey found that 60% of investors were bearish. 

That’s an extreme level of pessimism that allows stocks to continually slide day after day.

But it’s also the level of fear that can lead to significant market rallies. 

That’s what we’re seeing right now. 

The Dow is up 5% in two days. 

That’s good. Stocks rising is always good. 

However, the bad side is it’s right in line with historical market moves after high levels of investor bearishness. 

This chart Chartoftheday.com shows the type of returns based on the AAII survey:

 


The chart shows the level of bearishness in the AAII survey is highly correlated to future stock market gains. 

When few investors are bearish (e.g. less than 20%), the S&P 500 posts tiny average gains of less than 3% over the next six months. 

When most investors are bearish (e.g. more than 50%), the S&P 500 have historically risen 6% over the next six months.
In other words, the more the pain, the more the gain.

You’re seeing it play out right now. 

Before this rally most investors were bearish. 

Now stocks are jumping big. 

That brings us to the main question now – will this rally last?

Frankly, odds are not good. 

Big and quick rallies like these are normally driven by market mechanics (i.e. short covering) and not fundamental valuation changes. 

Today, nothing has fundamentally changed. 

The Federal Reserve might have signalled it will dial back its aggressiveness, but it’s still committed to another major rate hike. 

Complete revaluations of businesses based on higher rates are still in progress. 

Policymakers have not opened up the energy spigots of the world.

Consumer demand is still waning as consumers are getting hammered by inflation. 

All the factors that drove stocks down are still in place.

You can make the best of this rally though. 

If you take this chance to add more cash to reserves, odds are you’ll be rewarded for it in the next few weeks or months for the next time investors get too bearish.


 
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