There are a lot of challenges in investing. But one that’s particularly tricky is knowing when a market rally is, well, a rally.
Maybe it’s the start of a new rally? Or maybe the current one is running out of steam?
That’s where this week’s indicator comes into play. We call it the Rally Watch, and it helps us separate sustainable rallies from temporary bursts of enthusiasm.
It does this by tracking a set of breadth and sentiment indicators. On the breadth side, we look at how many stocks are participating in a move higher, because a rally that lifts only a handful of names is usually fragile. On the sentiment side, we focus on measures like volatility and investor surveys, which tell us whether optimism or pessimism is driving decisions. When enough of these indicators line up, the Rally Watch gives us a signal.
That signal — shown as the orange line on the chart above — represents the percentage of indicators within the Rally Watch Report that are in a bullish state. The higher the percentage, the stronger the signal. If the percentage climbs above 50%, a bullish signal is triggered. The green shaded areas show the maximum rallies (greater than 3%) that occur after that point, up to 12 months after the original signal.
As the performance box on the bottom shows, these signals are quite powerful. On average, the market has rallied about 21% after bullish signals, with an accuracy rate of nearly 83%. Not bad!
So what’s the current reading? The most recent signal came on May 12, when the aggregate of the indicators moved above 50%. That was important because it marked the start of a new rally after the April sell-off. At that time, pessimism had reached extreme levels, and we also saw several breadth thrusts — sudden surges in buying across the market. Together, those conditions told us that a sustainable advance was underway. Since then, global stocks are up about 9%.
But today, things look different. The thrust signals that powered the initial leg higher have expired, which means momentum is no longer the main driver of this rally. Breadth measures remain OK, but sentiment is showing signs of excessive optimism — which is concerning from a contrarian point of view. And volatility, as measured by the VIX, is starting to tick higher from very low levels — always something to keep an eye on.
Put this all together and what does it mean for investors? I’d call it bullish caution. Yes, we still like stocks and risk here, but the recent cooling in momentum and deteriorating sentiment suggests new buying opportunities aren’t great right now. A more bullish outlook would come if we saw optimism give way to pessimism, along with fresh breadth thrusts, which would help push the Rally Watch indicator back above 50%.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.