Market volatility has begun to level out over the last couple weeks. For instance, it’s encouraging to see the S&P 500* regain key technical levels last week – specifically reclaiming its 200-day moving average and surpassing the 20-day moving average.
From a technical perspective, this provided strength to close multiple days above the important 5,700 technical support level (although it did dip below on Friday). And we think this market traction can be attributed to a handful of macro developments:
- New optimism regarding geopolitical developments as tariff headlines are beginning to look less severe than feared.
- The administration's recent comments signaling that many countries could receive tariff exemptions, which would confirm suspicions that the primary focus is negotiating better terms for the U.S.
- This tempering of trade concerns begins to alleviate one of the major uncertainties weighing on equities.
Additionally, at the end of last week we received further positive macroeconomic data via the release of the February Core Personal Consumption Expenditures (PCE) index.
We can see the positive effect of these macro developments in improved technical conditions as volatility begins to collapse. For example, the market’s “fear gauge,” the CBOE Volatility Index# (VIX), has been elevated due to tariff concerns. However, future expectations eased and provided a sense of upcoming “liberation” for equities:
Additionally, we have a level of comfort ahead of upcoming inflation data as major pain points are moderating. For example, egg prices are down a lot in just over a month:
Orange juice futures dropped by 45% – the largest quarterly decline on record:
And gas prices are down 11% year-over-year:
These are anecdotal examples. But they provide an advanced picture prior to the broader inflation data that's coming out. In short, these are positive signs.
Additionally, in a somewhat contrarian manner, consumer sentiment towards the stock market has plummeted:
This is a positive contrarian indicator because historical analysis suggests this type of sentiment decline often precedes strong market performance. For example, three- and six-month median gains after sentiment declines like this tend to be strong with high win rates:
One could argue all this macroeconomic and technical data may not mean much in a vacuum. In a sense, we would agree. So, let’s turn to the underlying equity buying and selling data to see if there’s alignment.
It Appears the Forced Selling Has Washed Out
In mid- March a lot of ugly, forced liquidation damage took place. The peak selling was between March 10-13 (right-most circle) and compares with other past capitulation events:
How do we know if this forced selling is behind us?
We can get a real-time indicator based on any elevated trading flows. This is important because there is a correlation between increased activity as stocks fall and forced selling.
Similarly, when trading slows down, stocks tend to recover as a bottom is formed. Many people believe bigger volumes are necessary to feel bullish. But the opposite is true because more emotional activity exists during selloffs than during bull runs.
Based on this data, for the moment it appears the forced selling has washed out. This is supported by the trusty Big Money Index (BMI) from our friends at MAPsignals. The BMI is a 25-day moving average of netted “big money” investor buys and sells.
As the latest green circle below shows, the BMI appears to have begun its upward pivot:
Now let’s zoom in to see why the BMI pivoted. As the yellow arrow shows, it’s because selling dried up:
Slowed selling is good. It provides the market an opportunity to breathe and perhaps chart a different course. For that to happen, increased buying must materialize. This is the next phase that we will be looking to see before there is a true “all clear”.
Brighter Days Ahead
While painful selloffs don’t feel good for investors, we’ve pointed out how the data is shifting. In other words, the light at the end of the tunnel is closer than many think.
For example, even with all the uneasiness during this bout of volatility, philosophically we want to remind everybody that it's best to not equate volatility with losing money.
Why is that?
Well, since 1980 equities have averaged 10% annual gains despite median annual drawdowns of 14%:
So, stocks pull back every year but still finish in the green about 70% of the time. Pullbacks are part of the process.
Also, there is still plenty of handwringing about how we're headed for surefire recession. Our counterpoint would be to look at the bond market, specifically tight high yield credit spreads, which show little sign of recession:
Currently, high yield spreads are 3.4% above comparable Treasury yields, versus the 20-year average of 5.1%. If the economy was on the verge of cracking, we’d see significantly higher spreads, like in 2008, 2011, 2015, and 2020.
Lastly, going back to investor sentiment and contrarian indicators, the American Association of Individual Investors Survey shows bearish sentiment is almost off the charts:
There’s a -40% bearish reading and the average for this metric is 6.5%. As the chart asks, is there anyone left to sell their stocks? The fact that Big Money selling quickly dried up recently would indicate there aren’t many sellers left.
Furthermore, when there's nobody left to sell, it usually means a pickup in equities performance is soon to follow. Going back to 1987, the S&P 500 does best after top quartile bearish sentiment readings:
This historical context combined with the supportive macroeconomic and technical indicators discussed earlier is promising. It seems prices are coming down and markets are beginning to stabilize. If that continues, the bearish sentiment reversal will follow.
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*Past performance does not guarantee future results.
*Investing involves risk and you may incur a profit or loss regardless of strategy selected.
* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
# The CBOE Volatility Index is a measure of the short-term volatility of the S&P 500 indexes, indicating how quickly market sentiment changes and the level of investor confidence or fear in the market.
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