Greed takes over fear in the stock market, but don’t be lured into this short-lived rally

Please click here for an annotated chart of the Dow Jones Industrial Average ETF US:DIA, which tracks the Dow Jones Industrial Average US:DIA.

Please click here for an annotated chart of S&P 500 ETF US:SPY, which does the same for the S&P 500 Index US:SPX.

Note the following:

• The first chart gives a long-term perspective.

• The second chart gives a short-term perspective.

• The second chart shows that 60% of the rally is driven by a short-squeeze. In a short-squeeze, short-sellers feel compelled to buy to cover. This is artificial buying, and sooner or later it exhausts itself.

• The second chart shows a breakout.

• The second chart shows resistance zone that is overhead.

• The second chart shows RSI (relative strength index) divergence. In plain English, it means that RSI went up as the stock market price went down.

• In isolation, the second chart is giving an all-clear signal to buy stocks. However, investors should never look at only one time frame. It is important to look at multiple time frames.

• The conclusion from the first chart is quite different from the second chart. In total, the first chart is still showing that this is a relief rally, and the probability is reasonably high for the rally to fail.

• Earnings season is ahead. Companies are likely to cut or withdraw guidance.

• There is about $6 trillion worth of monetary and fiscal stimulus. In the short term that is helpful to the stock market. Are there no consequences in the long term of printing and borrowing money?

• Investors have said there was no warning of the coronavirus. That’s untrue. On Jan. 22, The Arora Report’s call was that the coronavirus could cause a drop in the market. After finding that investors continued to buy stocks, I wrote on Jan. 30 that arrogance and greed among momentum investors “may prove to be dangerous for investors.” Other than a potential cure, the course of the stock market rally will depend on the behavior of naked investors. Please see “‘Naked’ investors — not coronavirus numbers — will determine how much stocks rally.”

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

Key stocks

The rally in large-cap tech stocks such as Apple US:AAPL, Amazon US:AMZN and Alphabet US:GOOG US:GOOGL is showing that investors believe the coronavirus is not a big deal.

Semiconductors have been a leading indicator. The rally in semiconductor stocks such as AMD US:AMD, Intel US:INTC and Micron Technology US:MU would have you believe the coronavirus crisis is over.

Is the stock market getting divorced from reality? There are no vaccines or treatments for the coronavirus. It is true that there is a vaccine for the flu, and Tamiflu helps some people. The coronavirus is much more dangerous than the flu. In spite of massive efforts, there is no cure or vaccine for even the common cold. The HIV cocktail is a great success but it took many years for scientists to develop it.

Thus, the stock market is clearly divorced from reality.

Buy or sell?

Bear markets are characterized by sharp rallies. If a cure is found soon, the rally will continue. In the absence of a cure, the probability is high that the rally will fail. Investors should use an objective framework for buying and selling. Please see “Stock market investors are asking ‘should I buy or sell?’ Here’s how to decide.”

Answers to your questions

Answers to some of your questions are in my previous writings. You can access them here.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at [email protected].