There’s nothing more terrifying than hearing my 2-year-old daughter scream as soon as I leave her alone in a room.
My body reacts instantly, creating a rush of adrenaline that sets off a mild panic. Has she fallen off the couch onto our tile floors? Or is she just upset I left her alone?
That uncertainty keeps my adrenaline pumping. I calm down once I realize she was crying just because her favorite show ended.
Her cries sound the same whether there is real physical pain or just some frustration or disappointment.
The stock market operates in a similar fashion. When uncertainty rises, adrenaline pumps through investors, causing them to sell stocks and/or purchase protection, just because they don’t understand what is going on and want to protect the profits they’ve enjoyed so far.
Fortunately, that panic mode entered in late June is now starting to fade, giving us an opportunity to make some quick profits.
Since the start of the year, the S&P 500 has gone practically nowhere — it’s up a mere 3.2%. By comparison, both the French CAC 40 and the German DAX indexes have soared more than 20% since the start of the year, even after all the turmoil stirred up over Greece.
The U.S. stock market has stumbled through a series of scenarios with unclear outcomes, including dismal U.S. economic data, a Greek debacle and a volatile Chinese stock market. Investors responded with caution throughout, increasing cash holdings and adding bearish short positions, as they should.
But our investment director was recently in Greece, taking the pulse of the economy and sentiment in the euro zone — his guidance was spot on. Greece has come to terms with the European Central Bank (ECB) and begun to make payments again, dodging default. As a result, the various stock markets across Europe have started to rebound as fearful investors pile back into stocks.
We’re seeing a similar opportunity on Wall Street. Let me explain.
Skittish Investors Create Opportunity in the Stock Market
Over the past few weeks, American investors have been increasingly cautious.
According to the latest Fund Manager Survey for Bank of America Merrill Lynch, the percentage held in cash (5.5%) is at the highest level since the financial crisis. In addition, the American Association of Individual Investors (AAII) shows that there are fewer bulls now than at any time since 2009.
Through late June and early July, investors were purchasing more downside protection compared to bullish bets since the wild October market ride last year, according to the CBOE five-day average put/call ratio.
Each of these data points initially seem bearish. Traders were moving to the sidelines in expectations of a major European meltdown as Greece struggled under its debt. But the meltdown never happened. Sure, Greece has a long way to go to getting back on its feet, but the worst of the dark clouds have started to clear. And that leaves a lot of money sitting on the sidelines waiting to jump back into the market to take advantage of the signs of continued growth within the euro zone.
We’ve witnessed this scenario before.
Take the bottom the S&P 500 reached in October of last year, for example. At the same time, investors were loading up on put contracts as a way of protecting their portfolio just like we were seeing prior to Greece reaching a deal.
The S&P 500 rallied 7% in just two months following that October market low.
Another example was in 2013, when the AAII reported its lowest reading of bulls in the market since the financial crisis. Stocks jumped 5% in just one month.
And we all know what has happened since the market bottom was reached following the financial crisis of 2008 — which also marked the last time cash balances have been higher than today, based on the survey of fund managers. The U.S. stock market has been a bull market, with the S&P 500 soaring more than 200% from its 2009 low.
Considering the level of bearish sentiment that we’re seeing among investors, today’s rebound will likely be a modest 5% to 10% return, but that is nothing to balk at considering the S&P 500 has returned just 3% over the past seven months.
The Best Place to Play the Rally
An easy way to play this quick rally in the U.S. stock market is with Rydex Guggenheim S&P 500 Pure Growth ETF (NYSEarca:RPG).
The exchange-traded fund (ETF) focuses on large-cap growth stocks. It’s heavily weighted in Information Technology, Consumer Discretionary and Healthcare sectors. These holdings have assisted the ETF in outpacing the S&P 500 by roughly a third in the scenarios mentioned above.
Keep in mind this is a short-term opportunity. I would not recommend this ETF as a long-term hold. But in times like these, when investors are skittish to put extra cash to work and are hedging their bets, it pays to jump into the market.
As investors continue to find clarity, they will pour back into the stock market and equities will rebound in quick fashion.
As always, we will be diligent at identifying when the stock market is going through real pain and we will take the appropriate action. But that time is not today.
Editor, Pure Income