One Reason the Stock Rally Can Continue

Only three words really matter in a bull market: Buy the dip.

If you buy every time prices fall, you'll do darn well... At least, that was the world we lived in from the 2009 bottom to the start of 2022.

It's a different world today. We're in the first prolonged bear market in more than a decade. And investors have gotten burned too many times following the "buy the dip" mantra.

Instead, folks are now incredibly bearish – even though stocks have recovered in recent weeks. And one measure shows investors are near record bearish levels since the data began 25 years ago.

But this is what we want to see as contrarian investors. Buying after similar setups has led to double-digit gains in just three months. And that means stocks can continue their recent rally.

Let me explain...

The options markets are a simple way to see sentiment in real time.

Options are an easy way to make directional bets on the market. And because they're generally short-term contracts, they can clearly show what traders expect in the near term.

When these bets hit crazy levels, they can be darn useful contrarian indicators. One way to see it is the put/call ratio. This is the ratio of traded put options to traded call options.

A call option makes money when a stock goes up in value. A put option does the opposite... It goes up in value when a stock falls. So a high put/call ratio shows more folks are betting on a decline.

We've seen several major spikes in the put/call ratio in November and December. And those bearish moves happened even as stocks rallied. Take a look...

Investors have clearly moved on from "buy the dip." Instead, they're cautious about any recovery in the market. And they're buying lots of puts to protect themselves against another fall.

History shows they're making a mistake. That's because similar spikes in the put/call ratio tend to be stellar buying opportunities.

Specifically, there have been nine other readings above 1.2 since 1997. And stocks tend to outperform in the months that follow...

Stocks have gone up roughly 3.3% in a typical six-month period over the past 25 years. But you can crush that return if you buy during these kinds of setups.

Similar instances led to 10.1% gains in three months and 13.1% gains in six months. And in both periods, stocks moved higher 89% of the time.

"Buy the dip" might be dead... But it looks like it died at the worst possible time. Today's bearish sentiment tells us the current rally can continue. And stocks could rise another 10%-plus by early 2023.

Most folks will miss it. They'll assume the next leg of the bear market is around the corner. But with sentiment this negative, there's a good chance they're wrong.

Good investing,

Brett Eversole

Further Reading

"These fearful sentiment readings tend to pile up near market bottoms – right before stocks soar," Brett says. That's what's happening today. Investors everywhere are scared – even the pros. And all this bearishness could soon lead to a turnaround... Read more here.

"You need to recover your mental state so that you can recover your money," Dr. David Eifrig writes. Bear markets hurt. A lot of investors miss the opportunity when stocks start rising again. But these two tips can help... Read more here: Get Up When the Bear Market Knocks You Down.

Market Notes



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