Is this market bounce for real? A review of the evidence

Published Sat, Mar 19 20228:59 AM EDT

A roaring rebound rally in the last week that carried the S & P 500 up 6.1%, featured four straight 1% daily gains and recaptured just about half of the 13%-plus decline of the prior ten weeks raises one crucial question: Do dead cats bounce this high? A fleeting bounce and a durable bottom look similar enough at the start to make them indistinguishable with true certainty. In the current case, the most recent tape action is encouraging, showing a burst of demand for bruised-and-belittled stocks, while the broader trend indicators and macroeconomic weather fronts continue to give pause. Yet the weight of the evidence derived from piling observation and historical precedent on the scales makes the case for a trustworthy low being in the books quite plausible, even if the market has merely rushed up to levels where bears sitting on freshly collected house money can be expected to sell heartily. On an impressionistic level, take a moment to consider how thoroughly tested this market had become by early last week. Monday the S & P 500 entered the so-called "death cross," its 50-day average ticking below its 200-day, in an ominous-sounding turn that as it happens is not consistently a bad omen for the index's performance looking ahead. We also had some corporate-bond offerings withdrawn, sometimes a troubling sign of the capital markets growing stingy. Commodity houses and exchanges were in some distress over margin calls. And then, of course, the Federal Reserve came not only with its first interest-rate boost since late 2018 but a collective forecast of six more quarter-point hikes to come this year and a press conference by Chair Jerome Powell in which he took every chance to sound hawkish toward inflation and even called the labor market "tight to an unhealthy degree." And yet, stocks rallied, and rallied hard — suggesting that four months of obsessing over an aggressive Fed tightening campaign, since officials pivoted to all-out inflation targeting in November, had largely priced in the central bank's current intentions. Even Fed Gov. Christopher Waller's comments early Friday that he preferred front-loading the rate-normalization effort with half-percent hikes sooner than later was shrugged off by the market. Why the market rallied While this may seem a surprising or even perverse response, it's worth recalling that much of what the market wants from a Fed meeting is for it to be over, removing a worry point from the forward calendar, and in any case the first rate hike has never been particularly harmful to stocks. (The average S & P 500 annualized total return during the past dozen Fed tightening cycles is 9%, according to Truist Advisory Services.) The multi-day force of the rally earned several superlatives, including ranking as only the fifth time since 1950 the S & P gained more than 1% four straight days, according to LPL Financial. While this one showed the lowest total gain of the five instances, following the other four (in 1970, 1974, 1982 and 2020) the S & P was higher each time with above-average gains six and 12 months later. A couple of "breadth thrust" indicators kept by Ned Davis Research involving momentum surges on a 10-day basis were on the verge of triggering before Friday's rally, another old trader's tool that will get a test. Along the way, the market's fever broke, or it would seem so at least. Oil prices corrected hard off their momentum surge to $130 a barrel and then stabilized. Corporate credit spreads – widening out in somewhat worrisome fashion in weeks prior – tightened up nicely in synch with equities regaining their bid. And the CBOE S & P 500 Volatility Index (VIX) retreated below 25 after having spent more than two weeks above 30 in a agitated state, a period when prices paid for the nearest VIX futures was also above those of more distant months, an anomaly indicating a stressed and treacherous tape. Bespoke Investment Group reviewed prior instances when the VIX had spent at least seven days above 30 and then receded below. Beginning one month out and extending to a year from that point, the S & P 500 was up 80% to 90% of the time and returns were stronger than the norm. The downside exceptions came more than a year and a half into the 2000-2003 bear market. And how about the VVIX – the VIX of the VIX itself? This hypersensitive indicator eased back to a year-to-date low on Friday, a sudden outbreak of calm and stability nearly three months into an unsettled year. And for the legions of flow-fixated investors who believe hyperbolically that options-positioning clusters and market-maker hedging thresholds are the key short-term swing factors, the S & P on Friday surpassed the so-called positive gamma level, above which dealer hedging will tend to restrain volatility and support prices. (All else being equal, of course, which it rarely is.) With consensus earnings forecasts remaining steady in recent months, it's been hard to map the excitable market action to corporate fundamentals in aggregate, with index moves essentially compressing and re-expanding equity valuations. Significant or not, the S & P 500 this month bottomed right around 18-times forward 12-month earnings — essentially the pre-pandemic level and down from above 21 three moths ago. Helpfully, the equal-weighted S & P 500 traded under a 16 forward multiple, showing the overhang of the still-rich premiums of mega-cap growth. Meantime, companies are on record authorizing more than $1 trillion in share buybacks at a time when new equity issuance has dried to a trickle. Supportive if not in itself a further upside catalyst. Fear is rally fuel Even those inclined to expect further downside — and many close market observers a week ago were patiently explaining that the market had not had a proper downside capitulation — were aware that investor optimism and risk appetites had collapsed. This gauge of retail-investor mood sank back to six-year lows in bullishness by Tuesday. Fear is rally fuel, and some unknowable portion of this reservoir of fright has been burned up in recent days, but sentiment probably remains more help than hindrance to stocks for now. All of the above amounts to a pretty fair case that the bulls are well on their way to meeting the high burden of proof they faced after the market breakdown under the weight of Ukraine-conflict unpredictability, consumer inflation panic, a Fed looking to restrict financial conditions and various late-cycle indicators. Yet the counterclaims are not to be dismissed. The S & P 500 has only barely poked above its steep downtrend line and declining 50-day average. It has recouped half the correction losses, which is about where a "sell the rallies" impulse would kick in. Technical strategist Mark Newton of FundStrat says, "Overall, I don't think it's wrong to trust this bounce until it gives us a reason not to trust it," though he notes the move "seemed to consist of weaker groups bouncing from oversold levels, not true quality." Most bottoms start with short-covering and trashed stocks finding a bit of relief, for sure. Cloud software, online-retail, ARK Innovation and plenty of other aggressive-growth groups had furious bounces after brutal multi-month collapses, the charts resembling a backward check mark. Even if the market found some traction around a valuation floor, it's not clear what would get multiples to re-inflate much given spottier earnings growth and less-generous credit markets. For as slippery as the market has been, investor equity exposures were near a record high entering 2022 and even now the S & P is up almost 90% in two years, so it's not as if the market owes investors much in the grand scheme. And seasonal patterns in mid-term election years (for those who observe such things) calls for choppiness into the summer. In other words, there is some balance in the debate of whether the market is in a brief respite or lasting recovery, with last week at least enabling the bulls to offer a "so far, so good" assessment.

Traders on the floor of the NYSE, March 18, 2022.

Source: NYSE

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