With volatility comes opportunity. And what volatility! Thursday saw the biggest intraday gain in the S&P 500 since the wild swings as stocks were approaching their lows in March 2020. On Friday much of the rise was given back. Could the opportunity be that—whisper it—the swings are a sign that the great bear market of 2022 is finally getting close to bottoming out?
The truthful answer is that no one has a good explanation for the huge price moves. There is talk of short-covering, psychologically important levels for the so-called market technicians and put options reaching payout points, but none can be proven.
Fundamentals certainly don’t provide an explanation, because the big news was that inflation was coming in hotter than expected, pushing up bond yields and initially hitting stock prices.
“It’s interesting that a piece of news that we would think is a crystal-clear negative turned out to be positive,” says
a market strategist and keeper of Edinburgh’s Library of Mistakes, a collection dedicated to market errors. “That’s telling us something—we just have to work out what.”
Viewed in hindsight, the large intraday bounces during the pandemic were a sign that the market just wanted to go up. Investors were deeply pessimistic, so anyone who was likely to sell already had; when buyers stepped in, they overwhelmed the remaining sellers.
Investors are again deeply pessimistic. At the same time, the size of the fall in prices has many actively discussing when it might be time to buy, with the S&P down 26.7% at Thursday’s low since the start of the year. The combination of the pessimism and the willingness to buy raises the likelihood that the market starts going up again before it becomes clear that the Federal Reserve’s rate increases—the most obvious threat to stock prices—are done.
Even bond investors are beginning to argue that the rise in bond yields makes them a good value despite the threat of more rate rises on the way.
In this way of telling it, someone thought Thursday’s fall meant prices were down enough to start buying. Once prices started to rise, others who had been waiting for a low worried that they might miss out, and piled in, some perhaps because of technical factors, aka, lines on charts, others to lock in a profit on put options or short bets that make money when prices fall.
It’s a plausible story. But go back through history and you’ll see that similar intraday rallies didn’t often mark the low, and tended to miss the true bottom by many months.
Since 1990, the biggest days with intraday rebounds after a fall came amid the turmoil that followed Lehman Brothers’ collapse in 2008. They were followed by large bear-market rallies that fizzled out. Investors who bought and held at that point would have regretted it by the time the low came in March 2009.
There were similar temporary but large rallies after the big intraday jumps in October 1997, August 1998, April 2000, January 2001, July 2002, May 2010 and August 2011 (the last a brief burst of optimism shortly after the downgrade of the U.S. credit rating).
The bad news: Out of all similarly large intraday rebounds since 1990 at least as large as Thursday’s, only two—those of March 2020 and October 1997—were sustained. The others lasted a maximum of three months before making new lows.
The good news: Except in the 2001 and 2008 cases, the new lows weren’t much below the low reached on the day with the big bounce.
Maybe huge gains amid a mood of deep gloom tell us we are getting close to lows, even if it tends to work out badly the first time. If you think we’ll have a soft enough economic landing for earnings to rise next year by at least the 7.9% forecast by Wall Street analysts, stocks look reasonably cheap at about 16 times forward earnings. That’s down from an overpriced 22 times at the start of the year.
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My concern remains that there is a high chance the economy weakens next year and earnings come in worse than expected. The lagged impact of tighter monetary policy will hit hard. Europe faces recession combined with the risk of energy shortages if the winter is cold. Geopolitics are grim, while China remains committed to its economy-crushing zero-Covid policy.
Stock prices have come down a lot, so it is possible investors are anticipating all this bad stuff. Personally, I doubt it and expect this to be merely another bear market rally. But there is no denying that we’re closer to the bottom than we were, so it isn’t surprising that investors are again trying to work out when to buy, rather than when to sell. Eventually they’ll be right.
Write to James Mackintosh at [email protected]
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