The S&P 500 gapped lower at the open, making this the fourth consecutive day of large opening moves in opposite directions. One day the bulls are in charge, the next day belongs to the bears. As much passion as there is in the market, both sides have been equally wrong about this one.
Over the last few weeks, I’ve been discussing strategies to trade this rebound. Today I’m shifting gears and will get into why the market is doing what it is doing.
While it isn’t hard to point out a few historical examples of the market getting things wrong, the thing we need to remember is the market is right far more often than it is wrong. These cherry-picked instances ignore all of the other times the market got things right. This also means when the market is not doing what we think it should be doing, the very first thing we should question is ourselves. And even more important than who’s right or wrong, the market determines our profits and losses and by that measure, it is always right. Rather than fall into the argument of why the stock market should be dramatically higher or lower than it is right now, let’s figure out why it is where it is.
Tumbling 20% from the highs of only a few weeks ago is a dramatic move. But these are dramatic time and this kind of reaction is logical and expected. The world looks nothing like it did at the start of the year and that means the stock market should obviously reflect this new reality. Where we run into disagreements is if -20% is too hot, too cold, or just right.
At this point, most investors are encouraged by the moderating infection rates and they are hopeful people can start going back to work in a few weeks. This will require obvious adjustments to our old routines to include social-distancing and protective measures, but it will be a good start that gets most people back to doing what they need to be doing. There will be some outliers like concert venues and movie theaters that will continue suffering from bans on large groups, but the rest of the economy should start thawing soon. Or at least that is the market’s current expectation.
While the upcoming earnings reports will be some of the worst in history, the thing to remember is the market doesn’t care as much about what happened last month or what will happen next month, it is looking six months ahead and wants to know where we will be this fall. As bad as things look now, if the market expects economic activity to be picking back up this fall, that is how it will price stocks today. Everyone knows our economic numbers will be shockingly bad. But that also means we can assume this is already priced in. Just like the market, our attention needs to be focused on is where the economy will be six months from now.
As for this -20%, the bears think we haven’t fallen far enough and bulls believe prices are already too low. Split the difference between these two extremes and we end up right where we should be. That said, it is impossible for the market to stay at one level so we should expect these volatile gyrations to continue for the foreseeable future. But no matter how high or low we go, unless something dramatic happens (i.e. a vaccine is released or a flare-up races out of control), expect these big swings to cancel each other out and for the prices to move mostly sideways around these more moderate levels. That means buying the bigger dips and selling the bigger rebounds for the next six months.
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Tags: S&P 500 Nasdaq $SPY $SPX $QQQ $IWM
Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.