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A Bearish Scenario for the S&P500

We certainly live in interesting times when it comes to stock market investing, traditional stock market valuations are challenged by day-traders willing to take more risks than usual. 

Warren Buffett, the most successful stock market investor of all time, is criticized for not making any purchases during this crisis. Although sitting on a pile of cash at Berkshire Hathaway, did not buy the dip caused by the COVID-19 pandemic.

Now that the stock market recovered and some indexes even posted all-time highs, many start wondering where is the market going next? Is it more room to the upside or not?

Consumer Confidence Should Worry Bulls

Investors’ confidence has returned to the market – day traders attracted by fractional shares offered by Robinhood, and recently Charles Schwab, suddenly have access to the stock market without limitations on the amount to invest.

Obviously, it is easier to go long than short, not to mention the unbounded risk for shorting a stock – one can make 100% gain if the company goes bankrupt but exposes to unlimited losses if the price soars. Even in bankruptcy, companies found buyers willing to double or triple their money by buying stocks priced at a few cents and benefiting from the crowd effect.

However the risk here is that consumers have chased equities higher. A quick look at the historical correlation between the S&P500 and Consumer Confidence, reveals an interesting fact – the last three economic crises saw Consumer Confidence dropping to an average reading of 44, considering 1992, 2003 and 2009.

Nowadays, Consumer Confidence sits at 86, much higher than the average reading during the above-mentioned crisis. In a way, it offers an explanation for those sitting on the sidelines and refusing to buy at the current valuations. Buying when Consumer Confidence dipped below 50 proved to be historically correct – almost picking the bottom generated by the crisis.

The chart also shows that there is more room for Consumer Confidence to drop before a possible turnaround. The implications here are that the current turnaround we have seen in the stock market is just temporary, and the pandemic is not going to go away that easy. For the stock market to drop and join the Consumer Confidence move to below 50, the assumption is that the COVID-19 will continue to negatively impact the economy.

What will prevail in the end? Buffett’s wisdom or younger generations’ enthusiasm?

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