Every Rose Has its Thorn: Healthy Rally, but Risks Linger

Key Points

  • Technically, the rally off the Christmas Eve 2018 low has been record-breaking on several measures.

  • History shows fairly rosy returns after setups like this; but with quite a few interim thorns along the way.

  • Sentiment has begun to shift as the “smart money” starts to take some risk off the table.

At a recent client event I was asked about our ongoing view that volatility would remain elevated—specifically, whether the rally off the December 2018 low in U.S. stocks was an indication that our view might be wrong. As a reminder, heightened volatility does not only mean downside moves—it tends to mean sometimes-unpredictable and rapid shifts in direction.

What a difference an Eve makes

We never recommend short-term market timing and the action in the stock market over the past month or so is testament to the difficulty of market timing—especially if you’re making all-or-nothing decisions with your money. From the September 20, 2018 peak in the S&P 500, stocks suffered a near-bear market (-19.8%) through the close on Christmas Eve. On cue, Santa Claus made his appearance later that night and from that low, stocks rebounded slightly more than 10% through last Friday’s close.

Christmas Eve 2018 was punctuated by some panic selling and led to a massive shift in investor sentiment as per many of the more popular indicators thereof. The panic seen during several trading days in the fourth quarter led to 52-week new lows on the New York Stock Exchange (NYSE) soaring to such high levels that it got into the zone that Ned Davis Research (NDR) says is “so bad, it’s good.” In that rare zone, the market has historically done quite well.

In fact, as of January 9, 2019 the 10-day change in the S&P 500 advance/decline (A/D) line posted its largest-ever gain. According to Bespoke Investment Group (BIG), on Christmas Eve, it clocked in at -2,440, which was the most negative reading since August 2011. Ten days later, the 10-day A/D totally reversed to a reading of +1,938, which was the most positive reading since July 2016. It was the largest 10-day change (+4,378) in the indicator on record (see chart below)—and it wasn’t even really close. The next-closest reading to the upside was on 12/5/08 when it had a 10-day change of +3,755.

A/D’s Record Surge

10-day change in S&P 500 AD Line

Source: Charles Schwab, Bespoke Investment Group, as of January 10, 2019.