U.S. stocks have extended the fourth quarter’s gains this year, and investors expect the party to continue.
Ironically, this kind enthusiasm is the stock market’s biggest enemy.
The math and crowd psychology behind any supply-and-demand-driven market can be boiled down to this simple chain of events:
• Rising prices make investors overly optimistic.
• Buyers convert into owners (owners can only sell, not buy).
• Fewer buyers are left to bid up prices.
• Sellers will eventually outnumber buyers.
• Prices decline.
I discussed the exact inverse (excessive pessimism) of that chain reaction in October 2018: “Today’s stock market pessimism is a reliable sign of a pending rebound.”
The S&P 500 Index SPX, +0.70% has rallied about 10% since then.
The chain reaction