A Lesson From History on the Pandemic Stock Market Rally

Technical Picture for the Stock Market Remains Bullish

The first anniversary of when the World Health Organization designated the COVID-19 virus a global pandemic recently passed.

The impact of the pandemic on the stock market was brutal and not seen since the market meltdown in 2008, which was triggered by the subprime mortgage crisis. Prior to this, there was the technology meltdown in 2000 and Black Monday in 1987.

In each of those situations, while the doom and gloom surfaced and investors were trampling each other to exit the stock market, I saw opportunities after the excessive selling.

And just like it was in every market meltdown since 1987, rationality surfaced and investors jumped back into stocks. The result was stellar multi-year rallies to record highs.

Chart courtesy of StockCharts.com

The same pattern followed the pandemic-induced stock market meltdown that led to multi-year lows in March 2020. The aftermath of the excessive selling has been staggering. The Russell 2000 and Nasdaq have more than doubled, while the Dow Jones Industrial Average and S&P 500 have rallied by more than 80%.

The lesson is that major events occur that could trigger major selling. The key is patience to ride it out while adding positions.

Stock Market Volatility Back to Normal

The stock market volatility has stabilized and has declined to 52-week lows.

To gauge the market volatility, I like to look at the Chicago Board Options Exchange (CBOE) Volatility Index (VIX). It’s a reflection of S&P 500 option volatility and a good indicator of market volatility.

During the sell-off in March 2020, the VIX spiked to 84.26 and investors ran for the exits. The VIX subsequently settled down to about 20.

During the subsequent stock market rally, the VIX made four moves to about 40, driven by volatility. The last spike to 40 was driven by the generational short squeeze in January. The VIX is currently hovering at its base of about 20.

Chart courtesy of StockCharts.com

Small-Caps & Blue-Chips Blossom

Record moves were made by the Dow, Russell 2000, and S&P 500 during the week of March 15.

Small-cap stocks have led the way since November, driven by the risk-on trade and expectations that the economic recovery would pick up.

As of March 18, the Russell 2000 was already up by a staggering 18.1% for the year, including a six-percent move in March.

While I’m impressed by the gain, the rate of the price appreciation has been a surprise. The Russell 2000 is 3.6% above my initial target of 2,250, but I’m not making any adjustments yet.

As long as the bullish golden cross pattern holds and the index holds its 50-day moving average, the Russell 2000 will likely move higher.

A surprise in the stock market this year has been the blue-chip trade. Driven in part by a shift to value, the Dow has been attracting buying.

Chart courtesy of StockCharts.com

The Dow is up by a leading 7.2% in March and it trails only the Russell 2000 in 2021, with an 8.3% move year-to-date. The Dow is within one percent of my target and could ratchet higher as the global economy reopens for multinationals.

Another surprise this year has been the underperformance of the technology sector due to valuation concerns and rising bond yields. The 10-year bond yield jumped to a 14-month high of 1.8% on March 18.

The Nasdaq is significantly lagging in March and in 2021. This stock market index managed to bounce out of a recent move into correction territory but it continues to battle the 50-day moving average (MA). A sustained move below that level would be bearish and point to a potential retest of 12,000.

Chart courtesy of StockCharts.com

Given my initial estimate of 15,000 for the Nasdaq, this index has the most potential, being 12.4% away from my target.

The S&P 500 moved to another record on March 16, to within 17 points of my initial target of 4,000. A positive sign is the rising earnings estimates for the S&P 500, which I feel could see a higher target price.

Chart courtesy of StockCharts.com

(Data as of March 18, 2021.)

Analyst Take

At this time, the stock market is holding up, with indications of moving higher. A look at investor sentiment shows a bullish stance.

Sentiment on the New York Stock Exchange has been bullish in 92 sessions straight since the U.S. election on November 3. The Nasdaq’s sentiment has been bullish in 91 sessions straight.

Until the sentiment reverses or slows, I remain bullish toward the stock market, but I don’t expect intermittent adjustments.