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An Extremely Optimistic Market

The S&P 500 is up 10.6% year-to-date after rising 55% from the March 23, low. This is an extremely optimistic market.

In a period of 164 days since March 23, 2020, the S&P 500 has gained half of its value. A similar gain has only occurred once in October 2009.

Specifically, after the financial crisis bottom on March 6, 2009, the index rose 57.6% by October 29, 2009, due to central bank intervention.

There is no way for stocks to realize these gains without direct intervention from the central bank in fixed income markets. Although the Fed does not purchase directly any equities, other central banks do and that has been the major driving force of market rallies since the financial crisis.

It is hard to guestimate where the index would be without central bank intervention. In our opinion, best case scenario would be sideways moves with moderate to high volatility; that is a trader’s paradise. But what we have now is a passive investor’s paradise.

Technical analysis has failed many analysts. When there are players in a market such as central banks, technical patterns no longer matter. In fact, it has been very embarrassing for some well-known analysts in the past after calling tops due to formation of simplistic patterns such as wedges and triangles. This type of analysis no longer works, at least as long as central banks dominate the game.

An example of a bearish formation is the pin bar formed on the daily S&P 500 chart Monday of this week.

The index may have hard time to reclaim the high of the pin bar at around 3,646. However, central bankers around the world have started again talking about additional stimulus in the form of quantitative easing. Therefore, it may not be surprising to see new highs in the index after a few days or weeks of sideways chop.

Note that 219 stocks in the S&P 500 are in the red year-to-day. The driving force behind the rally this years has been gains in tech, healthcare, consumer defensive and a handful other sectors.

The top 39 stocks listed above have contributed to most of the gains year-to-date. About half of the stocks have P/E above 40 but no one cares about things like P/E nowadays; growth gets all the attention even if P/E is at 100 or even 500.

This is an extremely optimistic market and we all how that ends but we cannot know when. A lot of people will lose a lot of money and the financial and emotional pain will be excruciating. Diversification is more important now than ever but this is also a reason it has not been as effective recently with bonds and gold starting having problems. OTM options are expensive to use in a hedging scheme in addition to the fact that they do not guarantee a successful hedge. There are advanced synthetic products such as Equity Linked Notes that provide principal guarantee but these are usually custom products for the big pockets. So what is left? Prayers that central banks will continue pumping equity markets while passive investors send their checks to index funds and to those “do nothing” fund managers.


Charting and backtesting program: Amibroker

Data provider: Norgate Data

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