The Counterintuitive Nature of Markets

The Counterintuitive Nature of Markets

Posted on June 02, 2020
It seems that markets will do whatever they can to confuse the masses. Most of the time investors are logical and typically make decisions based on past experiences and their intuition.  Markets, on the other hand, are counterintuitive. 

Just three months ago, the economy looked great! The S&P 500 was at a new high and volatility was at low levels. What followed defied logic. The S&P 500 experienced a 34% decline followed by a 37% advance and is now about 10% off its February 19th high. The definition of a normal correction is a 10% decline from the peak.

Forget, for a moment, the 30% plus swings over the last 3 months. Is a 10% decline reasonable, based on all that has happened? The current projected  unemployment rate is now a about 15%, the outlook for  small business is dire, trillions of dollars were created, and distributed, out thin air, most major cities are experiencing rioting and civil unrest, and there is a heated election coming up with two dramatically different ideologies. Does -10% off the all-time high make logical since?

Volatile markets are not logical because the actions of investors have been emotional. Markets are driven by supply and demand. When the market participants become overly emotional, then markets will react in an irrational and counter intuitive way. What would appear to be the lowest probability of happening becomes likely. When the news was at its darkest and the market was at its low, investors intuition said “sell!” Now that the markets have gone higher, investors develop a sense of FOMO, or Fear Of Missing Out.

Last week, the stocks that got hit the hardest, in the downturn, like cruise liners,  and the Russell 2000 (small cap stocks) experienced the largest rallies. They went up even though the short, and long-term prospects are not good. The Nasdaq has been the leader, in terms of relative strength. Over the last 10 trading days, the Nasdaq underperformed, while the Russell 2000 significantly outperformed most other equity indexes. Who would have thought that a cruise line stock, like Norwegian Cruise, would be up over 200% since its March low after dropping 87% in February/March? In other words, investors have been participating in a dash for trash. Sound logical?
As market technicians, one of things we look for when observing markets, is a market divergence.  This occurs when either markets trend higher, while certain indicators are falling, or vice versa. We have brought some negative and positive divergences up in past updates. 

The Advance Decline Line measures market breadth or compares the number of stocks rising versus declining.  When markets rise, we like to see a rising tide lifting all ships, and not just a few large stocks pushing the markets higher.

Recently, there has been a slight negative divergence in the Advance/Decline Line:

Source: AIQ

We are seeing another negative divergence in the MoneyFlow Index. MoneyFlow measures the amount of volume when the security closes near its high for the day verses the volume when it closes near its low. Ideally, as a security or market rises, the MoneyFlow Index would also rise.  The chart below shows that in the S&P 500’s recent movement over the past 1.5 months, MoneyFlow has put in lower highs (a negative divergence).  

Source: AIQ

Bottom Line
The markets have seen an unprecedented, impressive run.  A pandemic that caused an emotion-driven fire sale was followed by an equally emotional market advance.  As of now there is no clear consensus as to where the markets will ultimately end up.  That said, the markets are currently extremely overbought and are likely to remain volatile. The recent advance has been primarily fueled by stocks that had previously gotten slammed.  According to Canterbury Indicators, most market indexes are still in a bearish state, and volatility remains highly irrational.
Canterbury Investment Management: Tom Hardin

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As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

Canterbury Investment Management: Tom Hardin

More About Brandon Bischof

Brandon is directly responsible for managing the Canterbury Analytics Group (CAG). To date, Canterbury Analytics Group has played an important role in advancing portfolio management from a loose art form based on subjectivity and obsolete assumptions to an adaptive process with scientific rules and methods capable of providing evidence based results and statistically relevant value add results.

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