These are unprecedented times of volatility for the stock market as investors remain bearish despite the eye-popping rebound since the March spiral. | Source: Johannes EISELE / AFP
- The Dow Jones has bounced back strong after the March selloff, leaving many in disbelief.
- Investors are now more bearish than ever with most expecting another market crash.
- This is a screaming contrarian indicator that could see the stock market rip higher.
This might be the strangest stock market in modern history. Despite record unemployment and a deadly pandemic, the Dow Jones is only 16% off its all-time high.
The bounce from the March 23rd lows has been nothing short of phenomenal.
And there’s a good chance it keeps ripping higher from here.
There’s one simple reason for this: investors are way too bearish.
Almost every major sentiment indicator is screaming pessimism. Investors don’t trust this rally.
The vast majority of traders are watching this bounce with disbelief.
This is how bull markets are born.
Investors haven’t been this bearish for 8 years
The latest AAII Investor Sentiment survey pegs bearish sentiment at 53% in May. That’s more bearish than the March 23rd bottom when true panic and fear ripped through Wall Street.
Admittedly, it’s not as pessimistic as the bottom of the Great Financial Crisis which hit 70%. But it’s the highest reading since 2012.
While it’s not an exact science, these peaks of pessimism have been lucrative buying opportunities for long-term holders. Just look at the bounce in stock values after each bearish spike.
Dow Jones disbelief rally
This isn’t the only data point out there. According to a new Bank of America survey, only 25% of investors think we’re in a bull market.
Almost 70% say it’s a bear market rally. They’re waiting for stocks to crash again.
And then there’s the latest Evercore survey. Less than a quarter of investors think the next 10% move in the S&P 500 is up.
Less than a quarter of investors think the S&P 500’s next move is up. Source: Bloomberg/Evercore
Everyone is waiting for the price to go lower.
And there’s more. A new Deutsche Bank survey reveals that only 19% of investors think the market will be higher in three months. 81% are neutral or bearish.
80% of investors think the stock market will be lower or unchanged in three months. Source: Deutsche Bank
Even the billionaires are nervous. Warren Buffett is dumping shares at a rapid pace. Stan Druckenmiller says this is the worst risk-reward market he’s ever seen. Chamath Palihapitiya says it’s all a bubble.
Record levels of cash sitting on the sidelines
Even if you don’t believe what investors say, look at what they’re doing.
$4.8 trillion is sitting in money market accounts right now. That’s money sat on the sidelines, earning almost nothing.
Investors are paralysed waiting for a better opportunity to buy back in.
Wait, so why does this mean the Dow Jones goes up?
It sounds crazy. If everyone is this bearish, surely the market will go down?
Actually, it’s usually the opposite.
First of all, everyone who wants to sell has sold. The panic selling is done. Anyone who got scared in March dumped their stocks and ran.
Hedge funds and leveraged traders got completely wiped out in the March crisis. They were forced to sell anything and everything to meet margin calls. That panic won’t happen again.
So a lot of the selling pressure is gone. That means it’s easier for stocks to tick higher.
Now we wait for the short squeeze
The next thing that happens is bearish traders start betting against the market – known as short-selling.
When billions of dollars of shorts start piling up against the market, that’s when we invariably see a ‘short-squeeze.’ I.e. smart money sends the market rocketing higher, liquidating all the short-sellers and adding yet more fuel to the fire.
And then the FOMO buyers come in. As the short squeeze pushes stocks higher, investors rush in to join in on the momentum.
Rinse and repeat.
Yes, we are looking at the worst economic crisis in modern history. Tens of millions unemployed, horrorshow economic data, disastrous corporate earnings. But the Dow Jones can keep pushing higher. Don’t be surprised if it keeps going.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. Unless otherwise noted, the author has no position in any of the stocks mentioned.
This article was edited by Samburaj Das.