(Bloomberg) — A shock rally in equities left Wall Street searching for something — anything — to explain how another red-hot inflation number turned into the best day for bulls in a week.
Among the answers: an increasingly solid position including well-supplied hedges, a time when the portal is watching the charts, and some less-than-awful earnings reports. Throw in some short covering, and the result was a run up to a peak in S&P 500 futures that was up 5% at the broadest level.
Expect the unexpected is the only mantra in a market where cross-currents are flowing from all directions, including a Federal Reserve bent on lowering inflation and keeping half an eye on financial stability. Thursday’s turnaround came after the S&P 500 had climbed half since erasing a pandemic low in 2020, a blow to wealth that, while still showing no sign of curbing inflation, could one day play a part in reaching that goal .
“It’s the nature of the beast these days when you get these big swings sometimes. We can all speculate what might be behind it,” said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. that there is more money shorter in the market, that there is more money that moves around based on algorithm, quantitative strategies. And at any time you can have a trigger that can create a 180 in the middle of the day.”
With the direction of stocks almost impossible, professional traders have been busy limiting their exposure to surprise moves. Institutions bought more than $10 billion in puts on individual stocks last week, a record for that group and close to the most ever by any trader cohort, according to Sundial Capital Research.
There was circumstantial evidence that the bets paid off immediately after the government’s report on consumer prices, which showed warmer-than-expected inflation. While equity futures were sold off, the Cboe Volatility Index, a measure of market anxiety related to options on the S&P 500, actually fell, which could be a sign of profit-taking by hedge traders. And as those positions were monetized, that prompted market makers to unwind their short positions to maintain their neutral position in the market.
“It’s a mix of short covering/put selling,” said Danny Kirsch, head of options at Piper Sandler & Co. “It’s a very good fencing event. It’s trading like running an event, selling your hedges, adding to market rallies.”
Elsewhere, there were signs of technical bulls, including the 50% below the 22-month rally that started in the S&P 500 in March 2020. When the index was below the 3,517 level, some observers took market with that. as a sign that the nine-month sale had gone too far.
Another buffer came in at the index’s 200-week average, a threshold that hovers around 3,600 and has become a battle line for bulls and bears in recent weeks. In 2016 and 2018, the long-term trend bucked the S&P 500’s big declines.
“We got off this level of support and that becomes self-fulfilling,” said Ellen Hazen, chief market strategist and portfolio manager at FLPutnam Investment Management. “There is so much uncertainty in the market and so many conflicting data points that the market responds to whichever is the latest.”
It’s the first time since July that the S&P 500 has ended an intraday decline of more than 2%, another wild swing in the stock market’s 2022 signature as traders grapple with the Fed’s policy path and its impact on measuring the economy. The index has posted 2% reversal days, up or down, six times since January, set for the wildest year since the 2008 financial crisis.
While providing support for tactical traders, wiping out half of the bull market’s bounty is another grim reminder of how brutal the market has been in 2022. The S&P 500 is only at risk of its third 20%-plus loss of the calendar year. century. The dream state is slowly rising in the regulated markets after the Covid-19 outbreak, leaving investors exposed to the influence of a hyper-aggressive Fed and bubble-like valuations.
One bullish argument that has persisted throughout the selloff is the resilience of corporate earnings. With the third-quarter reporting season about to get underway, bulls may be taking cues from better-than-expected results from companies like Delta Air Lines Inc. and Walgreens Boots Alliance Inc.
Despite this year’s $15 trillion wipeout, stocks are far from screaming buys. At 17.3 times earnings, the index’s multiple is above trough valuations seen in each of the previous 11-bearing cycles, data compiled by Bloomberg show. In other words, if equities recover from this, the bottom of this market will be the most expensive since the 1950s.
“People have realized that long exposure to risk assets needs to be stopped for some time. FOMO guides people to chase this rally,” said Larry Weiss, head of equity trading at Instinet. “Unfortunately, we still have plenty of time to spoil this rally.”
More stories like this are available on bloomberg.com
©2022 Bloomberg LP