In-depth Analysis

Have we reached a turning point?

Have we reached a turning point?

It’s often said that we are living in unprecedented times and though that phrase is probably overused it’s not necessarily used in the wrong context because these are unprecedented times.

We haven’t experienced anything like the current environment before, or certainly not within the adult lifetime of most of today’s traders. I have to think back to my childhood in the 1970s to remember a period of high inflation, rising interest rates, supply-side shocks, and a major conflict in a strategically important part of the world.

If we want to find concrete evidence of how unusual the current market is then we need look no further than the price action, within the S&P 500 index, in the immediate aftermath of the Federal Reserve’s decision to raise US interest rates by +0.50%.

Source: Ryan Lemond

The chart or histogram above plots the distribution of two-day swings in the S&P 500 index since 1970. What we see here is close to a standard distribution or bell curve, with most results clustering around the mean or midpoint.

However, the moves on Wednesday the 4th and Thursday the 5th of May are outliers.

The S&P 500 swang from closing +3.0% higher on Wednesday, to being -3.60% lower, at the close on Thursday.

We can see in the distribution above that such moves are rare beasts indeed.

It turns out that there have only been 8 occasions in the last 52 years when the S&P 500 swung as wildly in a two-day period. That’s 8 instances in just over 13,600 trading days.

We can confirm the wild swing in sentiment this week by looking at a chart that shows the percentage of Nasdaq 100 stocks that are trading above their 5-day Moving Average.

What we find is that at the market close on Wednesday some 83.33% of all Nasdaq 100 stocks were trading above their 5-day MA lines. But by the close of Thursday’s session, that figure had fallen to just 24.540%. A massive -70% decline as markets moved from risk-on to risk-off, in a single session.

Should we be surprised by these sharp swings in sentiment?

Probably not because the performance of many leading equity indices has been very poor since the turn of the year.

The table below shows the year to date, weekly and 1- day percentage change in a selection of global equity indices.

The – 21.30% loss in the Nasdaq 100 and Composite indices, seen in 2022, puts them well into bear market territory.

Technology and growth stocks are seen as being particularly vulnerable in a higher interest rate environment, and we have seen several instances recently, of the share prices of growth companies being hammered, on news of weak earnings and or slowing growth.

Netflix (NFLX) would be the prime example, its stock price is down by more than -50.0% over the last month alone. And down by more than -68.0% year to date.

Of course, growth is not the only equity style or investment strategy. And growth’s great rival value is having its day in the sun. The S&P 500 Pure Value Index is up over the year to date and the last 52 weeks.

So, what sort of stocks are in the S&P 500 Pure Value Index for it to have outperformed?

S&P 500 Pure Value Index composition.

The index is a mix of stocks from defensive sectors, such as Healthcare and Consumer Staples (the things we have to buy day to day), combined with financials, which have historically performed well, as interest rates rise, though that hasn’t been the case in this cycle so far.

The index also contains a significant weighting towards the energy sector which has been 2022’s best performer. The S&P 500 energy sector is up just under +45.00% over the year to date for example.

I think we can consider the price action in US equity markets this week as a turning point.
One that has made investors sit up and take notice, and which has forced them to acknowledge that the macroeconomic environment has changed, and is likely to continue to do and that simply buying the dip in growth stocks, isn’t going to cut it anymore.

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