To start off this week’s market commentary, we would like to refer to last week’s update:
Don’t get overly emotional or concerned about the daily fluctuations in the markets. More importantly, don’t get bogged down in the day-to-day reasons why markets oscillate in a certain direction. Market noise is louder in a bear market, where investors overreact to news events in both directions.
The market’s daily fluctuations during a bear market are random. Nobody knows if a day ends up, down or sideways. Let’s take last Thursday as an example. S&P 500 morning futures rose over 1.00% on news of worse-than-expected inflation. When the market opened, the index was down -2.25%, with the tech-heavy Nasdaq falling more than -3%. To the surprise of many, the many markets were actually higher within two hours of trading and the S&P 500 ended the day up +2.60%. On Friday, the opposite happened, with the index falling -2.40%. Why? Markets are emotional and noise is louder in a bear market.
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The daily fluctuations of the markets were random and the daily volatility occurred both ways. If we include today’s close of trading (Monday, October 17).th), of the 199 trading days in 2022, 66 of them were “outliers”. As a reminder, a “outlier day” is a single trading day ending in more than +/-1.50%.* Of those 66 outliers, 34 were down and 32 were up. So the bottom line of the daily fluctuations is that you can expect to see a outlier day every 3 days and it’s a coin toss whether the outlier will rise or fall. In fact, the longest the S&P 500 has gone without a breakout day this year is just 11 days.
You may be surprised by this, but there was not much difference between the number of “up” and “down” outliers, nor was there a large spread between the size of the outlier day. The average “up” outlier is +2.21% and the average “down” outlier is -2.45%. Investing only during the “up” outlier days would have returned +101%, while investing only during the “down” outlier days would have returned -57%. However, when compounding, large negative days have a greater impact. Cumulatively, breakaway days have accounted for -14% of the S&P 500’s overall decline this year.
Some technical notes
Volatility has come in waves over the past two weeks. The S&P 500 gained more than +5% in the first two days of October, followed by six consecutive down days that erased the index’s gains. Then came Thursday’s big move up and Friday’s big move down. All in all, the S&P 500 was flat for the last two weeks through Friday, posting +8% aggregate gains and -8% aggregate declines. That’s a lot of volatility to go absolutely nowhere.
This “sideways” volatility comes with the news and reactions of jobs data, inflation and the Fed. On a slightly positive note, given all the bad news and Fed speculation, the market has moved sideways near its June low. It seems that the sideways movement is the market trying to make a bottom, but it has yet to show that it wants some sort of sustained rally. We’ll see how the markets react during a poor earnings season that many have anticipated. So how will the market react when earnings are good and how will they react when they are bad? Well, as the data shows, it could go either way, but expect markets to remain volatile.
On the plus side and with caution, there is an old technical research company called Lowry Research. Their data shows that the most common theme near the bottom of a bear market is a series of days when the volume of rising stocks accounts for 90% of the stock market’s total volume. According to our good friend and experienced market technician, David Vomund, this has now happened three times this month following Thursday’s move. He continues, “Given the Lowry report, it’s constructive to have three days of volume up 90% near the June low.”
As far as the markets are concerned, there is not much new to report. They’re volatile, whether they’re stocks or bonds. It has become clear that this is not the 20% drop in the “V” and rapid rally to a new high that we have now seen twice in the past five years (see December 2018 and Covid for examples). This market has shown a pattern of lower highs and lower lows.
For the past two weeks, markets have moved sideways, but they have been volatile. You don’t know where the market opens or where it closes. What we do know is that the number of outlier days is not slowing down yet. Volatility is increasing, not decreasing. This is a bear market characteristic.
The Canterbury Portfolio Thermostat has taken steps to limit the number of outlier days recorded in the portfolio and is currently positioned to benefit from any potential near-term rally. Keep in mind that any potential short-term rally is unlikely to be sustainable and the portfolio will continue to make adjustments during this bear market. Bear markets take time to shake off, and it takes a comprehensive, adaptive process like the Portfolio Thermostat to profit from the volatility of a bear market.
*Outlier Day Definition: Canterbury defines an outlier day as any single trading day above +/-1.50%. We arrive at this definition through empirical studies of market states and bell curve data. During a Canterbury-defined bullish market state (defined using objective, technical indicators), the daily standard deviation of the S&P 500 since 1950 has been 0.75%. So, using bell curve math, a trading day greater than +/-1.50% (two standard deviations) should occur 5 times out of 100. During a low volatility bull market, you would expect around 13 outlier days in a single year. During a bear market or transitional market condition, breakaway days occur more frequently.
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