Why a 300-point Dow surge can be bad news for market bulls

When the Dow Jones Industrial Average screamed higher by 305 points Tuesday, reclaiming a nice slug of January’s losses, it was the second one-day spurt of more than 300 points in 2015, and the third in two months.

It’s tempting to see these buying frenzies as evidence of underlying market health — signs of powerful demand for stocks unleashed as soon as unnerving distractions like crashing oil prices or European debt negotiations recede.

Yet such quicksilver jumps aren’t what long-term market optimists should wish to see very often. They tend to appear in a skittish tape in a climate of low investor conviction, and result not from big investors being caught wrong-footed by a stray headline or sudden price blips.

Tuesday’s surge was linked to a wild 7% jump in U.S. crude-oil prices, which for the headline writers meant that the assumed burden on equities of the prolonged purge in oil had eased. Some attributed this to the decline in drilling rigs reported Friday or promises of reduced exploration budgets by giants such as Chevron Corp. (CVX).


Dow Jones Industrial Average, YTD

Yet more than anything such sudden dramatic gaps in prices suggest twitchy bear-market action as overeager traders who are pressing the downside trade ease up or are forced to retreat. In another reversal trade, the euro, which has been in an engineered retreat, also bounced against the dollar.
Rhino Trading strategist Michael Block says: “These moves have nothing to do with fundamentals.  They have everything to do with positioning.  Everyone is short. A few cover, then everyone does.  It’s a vicious whipsawing cycle.  And it’s not healthy.”

In a widely shared weekly market dispatch by Peters Capital chief investment officer Eric Peters, an unnamed but frequently consulted veteran stock-futures trader said last week, in response to the massive jumps in European stocks in January:

“The nature of the market’s changing, rallies are more violent, making it impossible for most to stay short. Market behavior has shifted, and the violence of the oil and dollar moves are too swift for investors to adjust. No stock market rallies that fast unless people are caught massively short.”

This doesn’t mean the quick, hyperactive rallies are any less “real” or that prices must break much lower to find organic long-term buyers and holders. The closing prices count, and the harsh, serial humbling of short sellers is a key theme of every bull market.

But in the shorter term, it continues to appear that the massive and unexpected moves in huge global asset classes have yet to be fully reckoned with by an investment community.

A halving of oil prices in half a year and the stunning rush toward zero by government bond yields in the developed world caught so much money offside that the daily adjustments remain rapid and untrustworthy.

When it comes to stocks, a key element of Tuesday’s 305-point upward burst was that it was led by the stocks and sectors that had been most damaged in the January decline.

Chris Verrone, technical market analyst at Strategas Research, calculated that during that rally the 20% of stocks that had performed worst in January were up the most Tuesday – more than 5% on average. The year-to-date winners lagged the broad market badly.

Similarly, energy stocks and those of “low-quality” companies (as defined by balance sheet health) handily outperformed, in a broad “mean reversion” effect.

Not what a strong bull market looks like

More generally, big gains in the market in a single day are not particularly representative of how strong bull-market advances work. Across all of market history, large single-day moves either up or down tend to be clustered in bear markets, near market bottoms and, to a lesser degree, near market tops.

The meat of a long market advance typically looks like a long upward grid of smallish successive gains and brief, trivial pullbacks, reminiscent of the New England Patriots monotonous attack of disciplined short passes rather than Hail Mary downfield gambits.

The relentless rally of 2013 is an ideal example of the gentle glide path of a well-scripted advance. On the way to a 30% rise in the Standard & Poor’s 500 that year, there were a few month-long stretches when the index failed to move as much as 1% in a day.

The current little spate of intraday fireworks doesn’t yet qualify as a storm cluster, though widespread predictions of a more volatile market in 2015 certainly seem to be validated in the early going.

Michael Hartnett, global strategist at Bank of America Merrill Lynch, is among those playing for a more jumpy environment across capital markets. In a client note Thursday, he says: “Volatility is in a win-win: Either growth recovers, in which case the Fed raises rates and bond yields are simply too low; or growth does not recover, and the risk of [currency] wars, dramatic shifts toward fiscal indulgence, or debt default will grow very quickly. Either way, volatility will rise.”

This sounds reasonable, and would make sense as a mature bull market becomes more susceptible to growth and policy variables.

Of course, a year ago — after a sloppy setback in stocks during January and nervousness ahead of an expected reduction in Federal Reserve money printing – this was also a common call. As it happened, stocks bottomed the first week of February and recovered to new highs featuring months of calm, low-drama levitation.

That’s the kind of ride the bulls should wish for now, rather than gaudy, headline-grabbing moonshots that few are well-positioned for anyway.

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