Investors held the sell button down all day today as all major S&P 500 sectors traded lower. The DJIA led the declines among major averages as recovery stocks were sold off for the second day in a row. There were more bad headlines weighing on sentiment, including another daily record in new COVID-19 cases across the U.S. that prompted curfews and some temporary lockdown restrictions in cities like New York and Chicago. 

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The positive vaccine news from earlier this week faded as optimism about economic growth was curtailed now that the reality of new lockdowns is setting in. Hopes for a compromise on a new stimulus bill before the end of the year were also dashed as the acrimony in Washington continues to grow.  

There was some relief in the U.S. labor market as initial weekly jobless claims came in below forecasts. But, if there are more lockdowns or business restrictions on the horizon, it's hard to see that trend sticking around.

S&P 500 50-Day Moving Average Spread
Chart courtesy Bespoke Investment Group.

Extremes

It's been a week of extremes in a year of extremes for equity markets. Positive vaccine and antibody treatment news on Monday and Tuesday, respectively, propelled recovery and value stocks to multi-month highs while investors ditched tech and stay-at-home stocks in hopes of a quick recovery.  

That sent the S&P 500 into what technical analysts call "Overbought levels." In technical terms, that means two standard deviations from its 50-day moving average. For simple investors like me, that just means way too much enthusiasm. You know it when you see it. 

Like a Rubber Band

As Bespoke Investment Group points out, it is not uncommon for the market to pull back when it touches these extremes. The same thing happened in September and we had a sudden correction. Big institutional money managers and quant-based investing shops have sophisticated algorithms that automatically buy or sell stocks or indexes when they become overbought or oversold, which is why you see the market trapped in a range like it is. 

But sentiment also plays a big part — especially in 2020. Markets were surging this week because of the vaccine news and the hopes for a stronger economic recovery in 2021. But the resurgence of the virus and the new lockdowns and restrictions that states and cities are putting in place have now shifted sentiment the other way entirely. 

The coronavirus doesn't care about moving averages.

Reasons to sell
Chart courtesy TheIrrelevantInvestor.

Individual Investors are Still Bullish

In our most recent post-election survey, you told us you were mostly bullish and had high hopes for equity market returns over the next 12 months. The election uncertainty played a part in that and we had yet to hear about Pfizer and Eli Lilly's positive vaccine and antibody treatment news, respectively, so your optimism was early. 

Your positive vibrations are not unique either. The latest reading from the American Association of Independent Investors (AAII) is at its most bullish since January of 2018. It's easy to forget, at the end of January 2018, the S&P 500 slid into a correction in an event we called "Volmageddon" as volatility erupted seemingly out of nowhere. It later turned out that crazy trading in exchange traded funds set off some tripwires that sent the market spiraling downward for no apparent reason.

Two Points

The first is that anything can happen in a market with human participants. 2020 is full of examples like that. We are led by emotion and we get too optimistic on good news and too pessimistic on bad news. There has been plenty of bad news this year, but any sign of good news has sent investors headlong into stocks. 

The second is that there is going to be a lot of bad news and headlines in the months ahead. The virus has control. But we've seen this before. Many investors who kept their cool and remained balanced and diversified across sectors and assets have made it through this in decent shape. More than a few have done very well. 

As an investor, you have to be prepared to climb walls of worry if you want to be successful. 

There have been many.