US investors: Cool-headed? Or just getting lucky?

Traders work on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
Traders work on the floor of the New York Stock Exchange.

Why are U.S. investors doing a better job of keeping their heads about them as the rest of the world threatens to lose theirs?

As intense selling sped from China's erratic markets this week and tore through the European trading day, the damage to American stocks has been relatively modest.

The Shanghai market has shed 13 percent this week and trading was halted minutes into the day to stem the liquidation. The German equity index is off 7 percent in the year's first four trading days. Yet the Standard & Poor's 500 index has given up "only" 3.8 percent.

The rhythm of trading has suggested global sellers have been desperate to dump risky assets in exchange for increasingly dear dollars, which has pressured prices in U.S. stocks up into the middle of the day Monday through Wednesday. Yet late-day rallies implied investors were willing to soak up some of the equities the rest of the world was dumping.

While the CBOE Volatility Index (VIX) has surged above 23 from 18 on Dec. 31, it remains below its December highs near 25 even as the market has traded below that month's lows. This shows less demand for downside options protection than might be expected given the swiftness of the New Year's market spill.

Larry McMillan of McMillan Analysis, publisher of the Options Strategist advisory service, noted that Wednesday "fit within the same pattern we've been seeing all week: lower prices all day, with a late afternoon rally. Obviously, the oversold conditions that are building up are attractive to some buyers, so it appears that they come in late in the day."

To put it glibly, the way the supply and demand has seemed to ebb and flow by time zone makes it look almost as if America is executing a global share buyback.

There are pretty good explanations for the relative fortitude of U.S. markets — so far, anyway.

  • Big investors entered 2016 in a fairly cautious posture toward U.S. stocks. December's Bank of America Merrill Lynch global fund manager survey showed professional investors had lower relative exposure to U.S. equities than at any time in the past eight years. And these managers' overall cash holdings had climbed above 5 percent, on the high end of their typical range.

Wall Street strategists were telling clients not to expect much from the market this year, and hedge funds — after a grinding, treacherous 2015 — limped into 2016 playing defense.

In this sense, investors aren't being resolute and cool-headed, but largely got lucky by not being too heavily exposed to risky assets as the nasty market action was triggered. Indeed, some fear has filtered into the crowd, as the Daily Sentiment Index among stock-index futures traders was at 5 on a 1-100 scale, a sign of lots of anxiety among short-term players.

  • While the disorderly weakening of the Chinese currency and related flight of capital has properly raised fears of another jagged global "risk-off" panic, not all that much about this episode is entirely new. Oil has been weak for a year and a half, and is extending that weakness. China first devalued the yuan in the summer — which jarred the markets. Corporate earnings have been weak, and 2016 profit forecasts likely need to fall. But these were all familiar entries on every list of "risk factors" coming into this year.
  • Credit markets have held together better, to this point. The way the oil-price collapse filters into equities has been through the high-yield debt market. Yet the global turmoil has not upset junk-bond conditions this week. While high-yield risk spreads are still elevated, they are well below the worst levels of December.

All of this helps explain the relative calm of the S&P 500 — which after all is still having a lousy start to the year and is at levels first reached 18 months ago. And it suggests the energy is building for at least a decent bounce if the global chaos ebbs even slightly.

But it doesn't mean that the underlying conditions can't get worse, or that U.S. markets will lose their composure if no relief comes to the global capital markets soon. The American stock market has been shuffling along the line separating bull and bear market for months now, with most stocks in ugly downtrends. The S&P 500 is now hanging around the path of the recovery that started after the 2011 global market slump.

Not every market setback requires an indiscriminate, panicky washout or capitulation in order to usher in a recovery. But if this one does, we're not there yet.