There is something good, bad, and ugly about the most recent rally in the S&P 500. Those who followed us know that we were constructive on equities lately and expected a significant reversal around the 2,350 level in the S&P 500. That proved correct so far. Nonetheless, it is time to get out of the stock market now. At least a retest of the March low is likely. Moreover, the character of the most recent rally increased odds that the March low may not hold during the next downturn.

Business Cycles

U.S. equities unfolded a sharp decline that erased more than one-third of its market capitalization during the first quarter. However, that happened within four weeks only. The bad news is that not even a single stock market correction that accompanied contracting business cycles finished that quickly if we look at the Dow Industrials from 1900. NBER recessions took on average eleven months in the post-World War 2 period. Moreover, the economic fallout from the COVID-19 related lockdown is severe. Hence, we are most likely at a very early stage of a relatively deep recession. While equities tended to recover before the economy, it is unlikely that the entire correction ended within four weeks. Instead, the drop during the first quarter of this year was probably just the first half of a bear market.


Retail investors fed the rally from the March low. Moreover, retail expectations are in contrast to professional investors’ expectations. The chart above shows accumulation in the SPY retail ETF on the Robinhood platform. Our sentiment indicator confirms this observation. Occasional investors bought the dip, whereas institutional investors sold over the past few months. The latest Bank of America fund manager survey reveals the highest cash quotes among active managers since the burst of the tech bubble in 2000. Historically, institutional investors tended to be correct if they contradicted retail investors.

(Source: Robinhood, James Bianco Research)

Sector Concentration

The market advance is concentrated in the technology and healthcare sectors. Other sectors are hardly participating, which is a contrast to previous bull markets. Bull markets tend to unfold a relatively slow and broad-based climbing. Today is different and many sectors display corrective patterns despite the strong rally. There seems to be something broken in the market’s engine.

(Source: Seeking Alpha)

Technical Pattern

The witnessed selloff severity of the past few weeks has never formed a cyclical low during the past 150 years – not even in bull markets. That hints toward a second half-time of the match ahead. Moreover, the subsequent rebound has all characteristics of typical bear market rallies. It was sharp, full of opening gaps, unconfirmed across asset classes, and retail investors’ sentiment went through the roof. The ugly thing is that the most likely technical patterns lead either to or even below the March lows sooner or later. A sustained break below 2,850 in the S&P 500 is the first technical hint that the party ended as the index fails to break out on the upside.


At least a retest of the March lows remains most likely. Historical evidence, investors’ behavior, and technical patterns hint to elevated risk on the downside. Long-term investors are most likely best off on the sidelines at this junction. It is very unlikely that the most prolonged expansionary cycle expands further. Instead, we are most likely within a recessionary environment. Risks are on the downside and retail investors have very optimistic expectations. Statistical evidence shows that retail investors’ expectations were negatively correlated with subsequent investment returns. The bottom line is that odds favor a substantial decline during the coming months.