Despite protests throughout the United States (over 300 cities protesting), the S&P500 recovery continues. Leading to many entering the market at valuation levels many would consider absurd in normal times. Yet, it feels the market sentiment is long-term positioning rather than excessive speculative moves many people fear. In other words, there is still room for more upside, a further disconnect from reality, as perma-bears like to say.
With the economy at its weakest point in over ninety years, the S&P500 is back consolidating around the 3000 level.
Excessive Speculation During Recessionary Times
A closer look at the chart above shows how speculative funds acted during past recessions. Moreover, it reveals what happened with the S&P500 once the speculation indicator reached values below -1. Every time it dipped below -1, the stock market pushed for new all-time highs, indicating that long-term positioning is explored around the level.
Judging by this metric and considering the divergence between the speculation indicator and the S&P500 in recent months, investors’ focus shifts now to the moment the indicator reaches -1. At that point, the long-term positioning may already be underway, and the flow of sensible influence in the index.
For some, strategies could involve a two-step approach. First, wait for the speculation indicator to reach negative 1. Second, wait for it to bounce above that level. Historically, whenever that has happened, the S&P500 made a new all-time high.
Of course, this is just speculation. No crisis is the same and requires different solutions each time. However, the business cycle has always been the same.
Booms and busts have dominated the stock market throughout the years, with complacent growth periods in between. According to the business cycle theory, after a market’s peak, a period of contraction follows.
Longer-term contractions lead to recessions and acute recessions to depressions. Only when there is no hope and investors give up, does the business cycle bottom and the economy picks up.
Both bulls and bears may argue that this time is different. Indeed, it looks like a depression similar to the one in the 1930s, rather than a recession like the one in 2008-2009. Nevertheless, one of the best ways to keep an objective view of economic conditions is to use the same metric for various types of economic booms and busts.
The speculation indicator is one of those metrics, showing that even at current valuations, more moves could be ahead.