Emotional Markets Go in Both Directions | ETF Trends

After a downward slide at the end of July and beginning of August, markets are attempting to recover losses. Through Friday, the S&P 500 experienced seven consecutive “up” days. Three of these up days qualified as “outlier” days (more than +/-1.50%).

Outlier days are irrational but will occur in both directions. In our previous market commentary, published on August 5th, we wrote:

“While markets took a punch to the face in the trading session on Monday, given the volatility that began early last week, there’s an argument that the market could have opened up +4% as opposed to down. If the market continues to be volatile, you can pretty much flip a coin as to which direction the market will fluctuate on a given day.” 

Since publishing that statement, all three subsequent outliers have been to the upside.

Since 1950, the S&P 500 has experienced a total of 1,779 trading days beyond +/-1.50%, or “outlier days.” Surprisingly, the number of outlier days that occur to the downside are almost equal to the number that have occurred to the upside. Since the beginning of 1950, there have been 885 “up” outliers and 894 “down” outliers.

Outlier days are most often associated with bear markets but do occur in the middle of bull market runs. Trading days beyond +/-1.50% often serve as a means to relieve pent-up pressure following an extended period of extreme low volatility. In our August 5th commentary, we wrote:

“When markets go extended periods without an outlier, volatility gets extremely low and “compressed” like a spring. Eventually, an outlier day or two will serve to release some pent-up energy. More often than not, market fluctuations return to normal following a few outliers.”

During a normal bull market, outlier days are expected to occur between ten and twenty times throughout the year. So far in 2024, there has been a total of ten outlier days, five of them up and five of them down. Seven of these outliers have occurred in the most recent two months, which is evident of inefficient trading. We are looking to see if the markets have any intention of settling down, or if volatility will continue to pick up.

Some Good News

The good news is that right now, the general trend of the markets over a longer run is “up.” There has not yet been a series of lower highs and lower lows. There is an argument that the most recent upward move off the August 5th low was due to a jump in pessimism. Markets are counterintuitive in that they will do the opposite of what most expect. Investor sentiment is therefore a contrarian indicator.

The August 7th American Association of Investor Sentiment Survey showed a +12% increase in Bearish sentiment, the largest weekly jump in bearish sentiment since November 2022. That year (2022) was a bear market, fueled by erratic investor emotion. It is odd to see such a large jump in bearish sentiment when the market has been in an uptrend, outside of just the last few weeks. Additionally, according to research by Bank of America Global Research, bonds have seen large inflows this month, while equities have seen large outflows. Perhaps the shift in sentiment has led the market to “oversold” conditions and caused a rally. 

Most large cap stocks have hung in there during the market’s recent decline and rally. The Consumer Staples, Utilities, Financials, and Real Estate have all made new 52-week highs. Most of the recent market selloff was due to the tech-related sectors, which had been overextended and due for consolidation.

The S&P 500 index’s Advance Decline Line, which measures the number of advancing stock issues versus declining ones, just hit a new high, meaning more large cap stocks are advancing than declining. Additionally, the equal weight S&P 500 index, an index which gives the same weighting to each of its 500+ components, is within a few ticks of its all-time high.

In other words, outside of large technology stocks, there is not much evidence of a broader bear market.

Bottom Line

The market is still volatile, with technology stocks driving most of that volatility. We continue to monitor whether that volatility will slow down, and markets resume normal or trading, or if we will continue to see outlier days in both directions.
The good news is that market breadth continues to improve, and the equal weight S&P 500 has bullish characteristics. Right now, markets have not set lower highs or lower lows, which are a bear market characteristic. Markets are, however, trading a bit inefficient. While it remains to be confirmed, recent market fluctuations could be an exaggerated result of too much pessimism. Either way, volatility does need to settle down.

Originally published August 19, 2024

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