Volatility has calmed down in the first two months of this year. Last year, 2022, featured 76 “outlier days” (a trading day beyond +/-1.50%). So, on average, there was an outlier day once in every three trading days. The market just had its first outlier day this month. This calendar year has had four outliers. Outlier days are emotional, irrational moves that are a result of high volatility. High volatility is the mark of the bear. While outlier days were very prevalent last year, they have become less frequent to begin this year, and volatility has declined as a result. We will see if that trend continues.
Now, that is not to say that this market is without its fair share of challenges. The classical set up of the bear market we saw last year, which featured high volatility and a stair step decline of lower highs and lower lows, will take time to repair. There is still a lot of “overhead supply.” In other words, there are still plenty of investors out there, who bought in at higher prices, and would like to sell into rallies.
Take a look at the chart below. This is a monthly chart of the S&P 500 dating back to last year. Sometimes, round numbers can have a psychological impact on investors, and right now, the S&P 500 is attempting to battle through the 4100 level. The 4100 “psychological” level is at a point of resistance where rallies have failed to break through in the past. It is also near a 50% retracement of the market’s overall decline, on a monthly timeframe.
Source: Chart provided Optuma Technical Analysis Software, via their Twitter account. Link to tweet
In terms of market technicals, here are our observations. The S&P 500 broke above its trend of lower highs and lower lows. It is also above its moving averages, with those moving averages aligned in a positive way. The 50-day moving average has crossed above the 200-day moving average. That is called a “Golden Cross.” These are positive long-term indications. That is subject to change, but for right now, that is reality.
As for the short-term, the market had been overbought and coming off of a rally that was led by technology stocks. Tech stocks had been hit the hardest in 2022. In other words, a pullback, like the one being experienced, is normal after a sharp rally. The ideal scenario would be for the market to establish another higher low, and then put in a new higher high.
The chart below shows that the S&P 500 has broken above its declining trend of lower highs and lower lows and is now attempting to put in higher highs and higher lows. It would be normal for the market to test its moving averages (the 50-day is in green, and the 200-day is in blue) for support as it attempts to establish a new, upward trend.
Source: Canterbury Investment Management. Chart created using Optuma Technical Analysis Software
On Tuesday, the market had its worst day so far this year. As a result, if we check our Twitter feed, there are many more negative tweets and comments today. On up days, the data seems to be reversed. In other words, investor emotion tends to be correlated with the market’s direction.
There is a lot to be said about market sentiment, and the effects that price changes can have on it. Declines create pessimism, while rallies generate optimism. Last week, we wrote that the Investor Sentiment Survey showed that investors were the most bullish they had been since 2021. Now that a pullback is occurring, the observation is that sentiment remains correlated to price.
Making buy and sell decisions based on emotion rarely leads to optimal results. Portfolio management is about having a process and sticking to that process. Our process, the Canterbury Portfolio Thermostat is about adapting to the market conditions that exist today, and not about making predictions as to where they might be a month or year from now. As the markets go through various gyrations, the portfolio continues to adapt and move in concert with changing market environments- bull or bear.