Markets are Counterintuitive

Markets are Counterintuitive

Posted on May 12, 2020
Highly volatile markets are counterintuitive; they do the opposite of what most investors would expect.  The market was sitting at an all-time high back in February and out of nowhere, someone pulled the latch and it fell through a trap door. As the news of the coronavirus began to circulate and coverage continued to broaden, investors entered a state of emotional panic and equity markets dropped at a record pace.

As the markets were experiencing the downturn, Canterbury produced a video on March 16th outlining 3 points on the current state of the market:
  1. Do not focus on percentage dollar gains/losses during emotional markets. Emotional markets cause fake pricing… the market is being driven by actions of irrational investors.
  2. The irrational daily swings are caused by investors acting in a heard-like mentality: the madness of crowds.
  3. Sharp declines are followed by equally sharp rebounds—do not make the fatal mistake of reducing exposure following a volatile down leg in the market.
Emotional markets tend to bottom before the news is the worst… volatility works both ways.  Big declines bring big, oversold rallies.

The expected emotional oversold rally began after March 23rd, the day of the most recent market bottom.  At that point, state closures and lockdowns had not taken full effect yet.  While many states had closed schools and restaurants, most had only begun to issue stay-at-home orders.  With the market bottom being March 23rd, 42 states had not yet had stay-home-orders go into effect (a list of stay-at-home order dates can be found at https://www.nytimes.com/interactive/2020/us/coronavirus-stay-at-home-order.html). In other words, the news had not yet reached its worst before the markets began to get better.

At the market’s bottom (March 23rd), Canterbury stated in a video update:
When you get this sharp of a drop, you will also get a sharp advance.  [Markets] become very counterintuitive, so when you get this advance or oversold rally, it is going to happen fast and in a matter of days, probably not weeks, and if you’re not in, you will not be able to get in.

That is exactly what happened.  Coming off March 23rd, the S&P 500 index retraced more than half of its overall loss in a matter of about 15 trading days, counter to what most people would expect.

Where are we now?
Today, the comparison between the new depression era economic statistics and the S&P 500 appear to tell two totally different stories.  Markets have remained in a tight range for the last few weeks after regaining over 50% of their losses when the news could not be grimmer. April saw an additional 20.5 million go unemployed, as unemployment rose to 14.5% (source: CNBC).  When you take the devastating economics into consideration, plus the government sending out trillions in stimulus, you have a very uncertain future outlook. Even as we reopen, with limited capacity, many predict that the economy will still struggle.  As Ben Shapiro, editor for the Daily Wire, put out in a tweet: “partial re-opening doesn’t save most of the economy—a 25% full restaurant is a bankrupt restaurant.”

Again, this goes to show the counterintuitive nature of markets. Even as the economic news may be grim, markets have not seemingly reacted to it in the way most people would think.  This goes back to markets overreacting both ways, i.e. an exaggerated downturn followed by an overextended rally.

Pushing economic news aside, here are the supply & demand facts of the market right now:
  1. The S&P 500 saw a -34% drawdown and 32% rally in just 49 trading days.  This would normally take years to occur, yet it occurred in just 2 months.  That is pretty weird… weird usually isn’t bullish.
  2. The S&P 500 represents the 500 largest US companies. While at the other extreme, the Russell 2000 represents small cap stocks. The difference, in performance between the two has been sizable. The Russell 2000 has not put in a new high since 2018 and fell -42% from its most recent February 2020 high. Even though the Russell has rallied, the breadth of the advance has been lacking, when compared to the largest capitalized stocks.
  3. Technology, by far the largest US sector, continues to be among the leaders. Markets tend to do better when technology leads the way. However only two other sectors have outperformed the S&P 500…  the healthcare sector and discretionary (which is mostly Amazon).
Bottom Line
Managing this type of environment is not about watching the financial news and drawing subjective conclusions or trying to predict the outcome that the Coronavirus will have on the markets or economy.

Markets are driven by supply and demand, which is in turn driven by investors’ beliefs and predictions about future pricing. Sometimes investors become confused and act irrationally, in a herd-like manner. Emotional investors, who act on their gut feelings, will most likely be wrong. On March 23rd, when things looked the bleakest, the markets rebounded when least expected. If you were not already in, there was little opportunity to get in. The markets saw a rare sharp drawdown, and just as quickly, an overexaggerated counter rally. What does this mean? “Fake pricing.”

Now that the markets have rebounded, it is time to adapt by owning a more diverse group of securities along with alternative ETFs including “inverse” index funds. The goal is to stabilize the portfolio by making the portfolio behave in a normal and stable manner, regardless of the wild swings the markets may experience.
 
 
Canterbury Investment Management: Tom Hardin

More About Tom Hardin

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.


Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.