Stock gyrations confuse market timers on playing the cycle

Bull or bear, the penalty for stocks has been the same lately. Fast and brutal.

Lockstep moves, up one day and down the next, are sweeping the market like storms as worries about inflation alternate with optimism the economy can weather it.

Tuesday’s swing, which saw more than 400 S&P 500 companies move in the same direction, is a pattern that has repeated 79 times in 2022, a rate that, if sustained, will surpass every year since at least 1997 would have.

Too hot a market makes life impossible for wannabe timers plagued by differing views on how to play the cycle.

A Bank of America study shows that an investor can count on the Federal Reserve’s rate cuts as a surefire sign of a market bottom, while another from Ned Davis Research suggests that entry after initial easing is for suckers.

“Macro trends come and go. And I don’t think there’s more than a handful of people who can actually claim to be predicting that,” said Brad McMillan, chief investment officer at Commonwealth Financial Network.

“I admire the intention behind it, but I doubt the usefulness.”

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The world’s largest stock market is increasingly behaving like a gigantic trade whose direction cannot be controlled on a day-to-day basis.

Tuesday’s losses, the worst in two years, were caused by hotter-than-expected inflation. Two straight sessions followed, with more than 400 stocks in the S&P 500 rising.

The S&P 500 fell 4.8 percent in five days to 3,873, erasing all of the previous week’s gains. It has now moved in opposite directions by at least 3 percent for three consecutive weeks, a period of volatility not seen since December 2018.

The whiplash is underpinned by fast-moving narratives. The latest highlighted downside risk, particularly after FedEx withdrew its earnings forecast on deteriorating business conditions, a worrying sign for the global economy.

“The conversation immediately shifted from ‘good earnings despite headwinds’ to ‘future earnings really challenged by higher borrowing costs,'” said Larry Weiss, head of equity trading at Instinet. “We took 4,100, 4,000 and 3,900 pretty quickly.”

All types of investors pay a price. This week’s commotion followed angry cover from short sellers who had cleared bets the previous week only to have to sit and watch the market confirm the bear move.

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While active managers are said to excel in volatile times, the price of getting even a few things wrong in a market as turbulent and correlated as this is expensive.

The danger of poor timing can be illustrated by a statistic that highlights the potential penalty an investor faces for missing out on the largest single-day gains. For example, excluding the top five, the S&P 500’s loss for the year jumps from 19 percent to 30 percent.

With Fed monetary policy arguably the single most important factor in stock investing these days, a big question is whether interest rate movements provide any clues as to how these stock cuts are evolving. The answer is not clear.

Bank of America strategists examined seven bear markets and found that the bottom always came after the Fed began cutting interest rates — an average of 11 months after the first hike. In other words, investors would be better off waiting for the central bank to turn dovish before getting back on board.

Ed Clissold, a strategist at Ned Davis Research, took a similar approach to the question, charting the distance between the start of an easing cycle and the end of a bear market.

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Since 1955, when the median bear market ended around the same time the Fed began cutting rates, his analysis showed that the range had been massive, sometimes years before or after.

“The data argues against using a single rate cut to declare a new bull market,” Clissold wrote in a note.

To make matters worse, the Fed’s actions are themselves a moving target. After inflation was misjudged as ‘temporary’, the central bank is under mounting pressure to rein in inflation, which has been stronger than expected for most of the year.

With the central bank poised for another big rate hike this week, the bond market appears to be changing its stance on when the Fed will reverse course.

A more aggressive Fed fuels bets that a rate cut will come sooner. As a result, short-dated Treasury yields rose more than long-dated this week, extending the yield curve inversion across different maturities.

Updated September 18, 2022 at 5:00 am

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