Investor sentiment is pricing in a lot of bad news…
After all, there’s plenty to be pessimistic about. Russia’s invasion of Ukraine is creating uncertainty around energy and inflation. And Wall Street is waiting for more clarity on the Federal Reserve’s plans for raising interest rates.
When investors grow uncertain, they tend to sell first and ask questions later. That way, they’re ensuring they have cash on hand to invest when the market bottoms.
So, when the data indicates investors are super cautious, it usually means better returns lie ahead. That’s what’s happening today. And it’s setting up a long-term rally in the S&P 500 Index.
Let me explain…
Pessimism is everywhere in the markets today.
One way to see it is by analyzing put-volume activity. Puts are an options contract used to lock in a selling price on a future date. An investor can use this as a bet on lower prices or to protect against any downside in an investment.
The chart below shows the 50-day moving average of total option put volume in the U.S. This is a measure of the amount of equity and index put volume that traded on domestic exchanges…
You can see the volume has reached its highest level on record. There’s even more pessimism now than during the pandemic downturn in March 2020.
Brokerage firm Goldman Sachs confirmed this. It said $1 trillion worth of put contracts changed hands in a single week last month. That’s compared with an $800 billion figure near the S&P 500’s pandemic-driven lows in March 2020.
We’re seeing a similar indication from the CBOE Volatility Index (“VIX”). The gauge is a measure of risk sentiment. When the value rises, it means investors are scared. Currently, the number is above 34.5, the highest level since January 2021.
Historically speaking, that level of fear can lead to solid investment returns. Take a look at the following graph from financial market-data provider Refinitiv. You can see that when the VIX has remained above 30 for an extended period of time, the S&P 500 tends to rally over the next year…
Simply put, investors are scared today. But historically, that fear points to strong future returns.
I know this is still a scary time… And no one knows how it’s going to turn out. There are plenty of reasons to be cautious right now. But history shows patience and persistence will pay off.
I’m not saying to throw all of your hard-earned dollars at the stock market right now… But at the least, do your homework. That way, you’ll be able to sleep at night… especially when you decide it’s time to invest.
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Source: Daily Wealth