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More gains to come for stocks?

The rally has entered its fourth week, and shows no real sign of turning around. Admittedly, gains have become harder to find and, crucially, harder to sustain, but it looks like the default path is still higher.

CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.
US trader at work
Source: Bloomberg

This might seem a brave call to make but with breadth across indices still strong, investors still pessimistic and ongoing moves higher underway in other key markets, the evidence seems to point to more gains.

One point to note is that strength was led by the small caps, typically a good indication of risk appetite. In London the FTSE small cap index rose 3.2%, versus a 0.9% gain for the heavyweight FTSE 100. In New York, it was the Russell 2000 that strode ahead, up 4.3% compared to 2.7% for the S&P 500. Usually these lead the way, either higher, or lower, so for now the buyers are back in charge.

It was another good week for oil, with US light crude back above $36 for the first time since the beginning of January. The rising trend of the past few weeks remains intact:

For the S&P 500, the trend is still higher. The index pushed on beyond the 50-day simple moving average (SMA), and saw further gains that solidified its hold above this indicator. Admittedly, the percentage of S&P 500 stocks above their respective 20-day moving averages is now above 80%, normally at a level that can signify reversals, but we have to wait for price action to confirm this.

Crucially, investors remain sceptical about the rally. As the old saw has it, ‘markets climb a wall of worry and descend the slope of hope’. This bit of folksy wisdom implies markets tend to rally in the face of a broader bad news environment. The data to support this stems from the idea that extreme pessimism, as collated by sentiment surveys, tends to see extreme bullishness near market tops, whereas sharp drops cause private investors to become bearish. A further enhancement of this comes from Mark Hulbert of MarketWatch, who looked at the recommended Nasdaq exposure as stated by market timers:

As we can see, bullishness hit a high near the top during October and November last year. With market timers still short, a further rally seems likely, as a positioning can swing all the way into bullish territory, with money flows coming along.

Finally, we continue to see equity outflows from US mutual funds and ETFs. Twelve out of the last thirteen weeks have seen outflows from these funds, as investors reduce their equity allocations in the face of volatility and falling markets. We can expect to see upside momentum accelerate when these outflows turn to inflows, as ‘Fear Of Missing Out’ (or ‘FOMO’) grips investors.

Finally, we have the mid-February BAML fund manager survey to refer to; this noted that cash balances at fund managers are at multi-year highs. As equities rally, we may see more of this cash deployed, thus adding further fuel to the rally that began almost a month ago. 

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CFDs are a leveraged products. CFD trading may not be suitable for everyone and can result in losses that exceed your initial deposit, so please ensure that you fully understand the risks involved.