Stock market bends but doesn't break despite worsening Ukraine news and spiking oil prices

Published Sat, Mar 5 20228:57 AM EST

Blisters come first, then calluses. The stock market has been rubbed raw by unyielding friction from geopolitical strife, commodity-supply shocks and tighter financial conditions proceeding from the Ukraine invasion and sanctions – aggravating elements applied to a tape already pressured by growth-stock valuation compression and coming Federal Reserve tightening. This is not one of those environments when the crucial short-term drivers are hidden or subtle – the Ukraine headlines are the proximate prompt for the moment-to-moment action. But these twitches (the average daily S & P 500 range in 2022 is 2%, the highest at this point in a year since 2009, says Bespoke Investment Group) are all happening within a pretty defined range so far, the Jan. 24 intraday low in the S & P 500 of 4220 briefly undercut and arguably retested exactly a month later. To the upside, the late-January bounce reached near 4600, failing to prove itself more than a mechanical oversold rebound. Which raises one of those half-full-or-empty questions: Is it significant that the market in the past week was served up more worrisome news on the Russian invasion, further highs in oil prices and the U.S. dollar for unwelcome reasons, without buckling to new lows? Is this a hint of resilience, of the market's skin toughening up in adaptation to the known irritants? Or more a measure of how much downside remains unrealized in equities relative to the macroeconomic picture and emerging credit stresses? What, in other words, has apparently been priced into this scuffling market, down 10% in the S & P 500 yet still a couple percent above where it traded weeks before Ukraine had migrated from page A8 of the newspaper to the front page? The answers aren't a matter of scientific precision, of course. These are markets, after all. And a decent definition of a bear market – if it turns out this is what is underway — is one where the overshoots occur to the downside and the rallies are feeble and fleeting. A CBOE S & P 500 Volatility Index stuck above 30, as the VIX it is now, and with near-term VIX futures priced anomalously at a sharp premium to more distant ones, reflect heavy concentrations of stress hormones running through the market. The same goes for the dislocations apparent in short-term bank-funding markets, wide spreads between overnight money rates and those a few months out. None of this means acute systemic peril is at hand, but they are signals that will keep professional investors hesitant to add risk until they ease. Building a bull case All that said, here are a few exhibits entered into evidence to suggest the stock market has gone a good distance toward building some calluses against heightened event and economic-slowdown risks: Typical drop around geopolitical crises Deutsche Bank strategists note that the typical market adjustment around geopolitical crises is a drop of 6-8% in the S & P 500 over about three weeks, and the market is off about 8% since the Ukraine war began jolting oil and dominating investor attention. Clearly this is a mere average and the present situation retains an ability to scare traders, though the S & P 500 futures' drop overnight Thursday on word a nuclear power plant had been attacked stopped at Tuesday's intraday low just under 4300. Signal or noise, it's anyone's guess. Deutsche also calculates that the S & P's descent well under its 200-day average roughly prices in a macro slowdown that would sink the ISM manufacturing gauge under 50 from its latest reading above 58. JP Morgan technical strategist Jason Hunter sees reason to believe the index's recent lows between 4100 and 4300, which take it back to July levels, have a good chance to hold. This range represents the 10-15% pullback zone, and Hunter says, "Setbacks associated with the initial Fed policy rate hikes in each of the last four economic cycles all measured to that amplitude. Every time, those six-month consolidating ranges led to resumptions of the bull markets within those economic cycles." Meanwhile, Citi U.S strategist Scott Chronert's "bear market checklist" had only five of 20 components flashing red as of Friday, which suggests this downturn is buyable rather than the start of a deep and lasting downturn. And the flight to safety in Treasuries still left the 10-year yield above its old breakout level of 1.7% and kept the longer-term uptrend intact. Oil peaking? The stunning 25% ramp in WTI crude oil last week alone to $115 a barrel distills a few key investor fears, all rational even if they prove overpriced in the short term: a lasting throttling of Russian oil supplies, a squeeze on consumer budgets and persistent upward pressure on headline inflation that the Fed is determined to restrain. When price momentum comes from a scramble for physical oil by price-insensitive buyers, the moves can surely get wilder still, just as the refusal of buyers to accept oil deliveries in 2020 briefly sent a crude-futures contract into negative territory. Still, there have been many event-driven oil supply shocks in recent decades, from wars to storms, and this is how they behaved, on average, according to Ned Davis Research. This chart shows the average price path in the months before and after the shock struck. For what it's worth — and, truly, who can say —crude by Friday hadn't managed to take out Thursday's morning high even as the news flow on potential further supply restrictions remained nothing but supportive. And crude-futures traders' short-term bullish sentiment has, quite understandably, stretched toward an extreme. Extreme negative sentiment Speaking of extremes in sentiment, equity investors are about as pessimistic as they've gotten outside of crash-like scenarios. The weekly Investors Intelligence advisors survey showed bears slightly exceeding bulls to a degree essentially matching the Covid crash low, the late-2018 20% sell-off and the late-2015/early-2016 Fed rate hike and industrial-and-energy earnings recession tailspin, an episode I've noted repeatedly resembles the current setup. Resilient earnings outlook Among the things that have not quite fallen apart are the corporate-earnings picture. Companies aren't beating forecasts as handily as last year and first-quarter estimates have slipped slightly. But for the full year 2022, the consensus projection for S & P 500 profits continues to rise, nearing $226 a share, according to FactSet. This leaves the index just above 19-times this year's earnings. Hardly cheap, though the index bottomed in late February at a post-Covid low near 18.5. For sure, a slowing global economy leaves the forecast vulnerable to cuts, but perhaps the 10% drop in the index means the market isn't oblivious to this possibility. Bottom line None of this should be mistaken for an "all clear" message for the market. Investor equity exposures entering 2022 were quite high and could have plenty of room to decline still. Broad momentum has been lacking on recent rallies, leaving the bulls with plenty to prove. And a Fed intent to start a rate-hiking campaign in a week and a half with the VIX now at 30 is a slightly vexing and possibly unprecedented scenario. But it's best when acknowledging such pressure points not to dismiss the possibility that the market has been building up some protection against them for months, and a mere easing of the bad news could translate into quick relief for a stress-tested market.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, New York, U.S., March 3, 2022.

Brendan McDermid | Reuters

Blisters come first, then calluses.

The stock market has been rubbed raw by unyielding friction from geopolitical strife, commodity-supply shocks and tighter financial conditions proceeding from the Ukraine invasion and sanctions – aggravating elements applied to a tape already pressured by growth-stock valuation compression and coming Federal Reserve tightening.