(Bloomberg) — It’s become a dependable cycle. At mid-month, the S&P 500 Index craters, then recovers. Signs are mounting that this time around, the trauma could last.
Yes, U.S. markets again fell just before options expiration, and yes hedgers were prepared — dip buyers hobbled back on Friday. But the sheer force of the midweek selloff was enough to send volatility gauges to some of their biggest increases of 2021, and a host of other indicators show the rough patches are getting harder to shake off.
Buyers disappeared at times of stress. Charts tracking momentum threw off extreme readings. Economic growth is slowing and the Federal Reserve is talking taper. While none of these factors alone is likely to derail the market’s slow slog upward, taken together they’re worrying signs.
“We should expect to see more volatility and bigger pullbacks than we’ve seen over the past few months,” Michael Fredericks, the head of income investing at BlackRock Inc., said in an interview on Bloomberg TV with Jonathan Ferro. “A lot of the easy money has been made and valuations are rich. Going forward, it will get tougher.”
With stocks breaking the summer lull amid a resurgence in Covid cases and a widening regulatory crackdown in China, buyers did resurface — the S&P 500 erased an intraday decline Monday and again Thursday. Yet it was not enough to save the index from its biggest weekly slide in a month. In the five-day period, the Cboe Volatility Index, or VIX, jumped the most since June.
One extremely wonky indicator shows subdued impetus to buy this month. The gauge is known as the “tick index” and provides a reading — down to the second — on whether individual stocks are finding buyers right after rising or falling. With readings above 1,000 typically viewed as signaling an urge to invest, the index stayed below that threshold for 13 full sessions through Thursday, the longest stretch in three years.
While the tick’s direction is a function of how the overall market is moving, technicians view it as a closer lens into how crowd psychology is playing out in exchange microstructure. Broadly, the exuberance that has propelled the S&P 500 to the fastest rally in nine decades is cooling.
One widely cited reason for caution is the extreme nature of the advance. The benchmark has gone nine months without a 5% pullback, a prolonged period of buoyancy that has occurred only two other times during the past 25 years. In other words, a retrenchment is overdue.
Viewed from a wider lens, the picture looks no more sanguine. Plotting an inflation-adjusted version of the S&P 500 against its prevailing trend in place since World War II, David Rosenberg, founder of Rosenberg Research & Associates Inc., found the index now sat 79% above its trend line, an extreme deviation that only happened in 1966 and 2000. Ominously, both years marked the peaks of bull markets.
The chart “suggests to us that the gains investors have become accustomed to of late will not persist,” Rosenberg said. “This is yet another reason why we feel we are in the latter innings of this historic rally.”
To be sure, equity funds continued to attract money, partly because rock-bottom bond yields make stocks a better destination for investments. Thanks to robust earnings and the perceived haven status as the home to some of the world’s best companies particularly in the technology sector, the S&P 500 has scored 49 all-time highs this year, including one on Monday.
But cracks are surfacing in areas where stocks are viewed as economic barometers. The Russell 2000 of small caps this week briefly fell into a 10% correction from its March peak amid six consecutive days of losses, the longest slide since the 2020 bear market. That came one month after the Dow Jones Transportation Average suffered a similar blow.
While sticking to equities, professional investors are turning more defensive in August, raising exposure to cash, health-care and utility stocks while cutting positions in cyclical shares like energy, according to the latest Bank of America Corp. survey. With their expectations for growth rolling over, money managers are likely to start trimming stock holdings, as they did in the past, noted BofA strategists led by Michael Hartnett.
“I’m starting to lean toward an actual turn,” Paul Nolte, portfolio manager at Kingsview Investment Management, said by phone. “It doesn’t mean that the market turns tail tomorrow, it’s just that you want to start paying attention to what the market’s doing and maybe start taking some risk off the table.”
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