Making sense of the strange rallies like the market saw on Monday

Published Tue, May 3 20228:55 AM EDT

What accounts for these head-scratching rallies we have seen recently? Monday, in the last hour of trading, the S & P 500 rallied 80 points in a half-hour. There was no news, and certainly no fundamental reason for an 80-point rally off the lows, especially since stocks were drifting lower throughout the morning. What explained that rally? There are the obvious explanations: 1) oversold conditions, and 2) it's the first of the month, traditionally an up day because there is usually new money coming in. All possible explanations, but the most likely explanation is simpler: poor liquidity. What's poor liquidity? When things get crazy — and it's been crazy recently — the trading community reacts in a very predictable fashion. They post smaller sizes, and the bid-ask spread gets wider. This has the effect of magnifying modest moves in the market. For example, if you want to buy 100 S & P 500 futures contracts, three months ago you might have moved the market, say, 2 points. Today, you might move the market much more — say, 4 points — if you want to fill that order in a hurry. That's a sign of poor liquidity. How does poor liquidity translate into an 80-point rally in a half an hour? Buyside traders keep a large part of their orders for the end of the day. So instead of apportioning 15% for each hour, a buyside trader might have 25% of what he needs to buy held for the close. In a market with poor liquidity, when you get modest buying pressure the sellers that were there vanish, and markets have to lift to attract sellers. There's a rapid feedback loop that pushes prices higher fast. By the way, the opposite happened early in the day. Stocks were drifting lower on moderate volume because there was no buying interest. This is the classic mark of poor liquidity. One other point about Monday's rally: Several traders messaged me to note that this was just before a Fed meeting, and attributed part of the rally to "Fed drift," the tendency of the market to rise going into Fed meetings. Is the Fed drift back? The old pattern, which saw stock prices rise going into a Federal Open Market Committee meeting, hasn't held up too well recently. Steve Sosnick at Interactive Brokers notes that since March 2020, the S & P has closed lower in the three-day period following 10 of 12 meetings. But since the Fed began to get more hawkish in September 2021, the pattern has changed again. Since then, four of five post-meeting periods have seen a higher close, Sosnick told me.

Traders work on the floor of the New York Stock Exchange.

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What accounts for these head-scratching rallies we have seen recently?