(Bloomberg) — In a week that saw discretionary buyers win a quick retreat from risky assets, another set of traders rose to the occasion to halt a three-week plunge in the S&P 500: those with little choice but to to buy.
They included short sellers, whose rush to cover inflated stocks they bet on at profits more than double the market. Options traders were another bullish force after they were caught needing to shore up hedgers by buying stocks when they rise. Some quantitative traders for whom chart limits are a call to action also made their presence known.
Combined, these players helped the market ride out a new wave of selling by day traders and capital investors. Up 3.7% during the holiday-shortened week, the S&P 500 rallied on a persistently hawkish message from Federal Reserve Chairman Jerome Powell. While it’s debatable how much bad news is priced into the 2022 bear market, the prevailing skepticism toward stocks makes Andrew Slimmon optimistic.
“There’s just a huge negative bias to the market right now and that’s an extremely contrarian message,” said Slimmon, global head of equities at Morgan Stanley Investment Management. “Markets are set for a very good fourth quarter. There are a lot of funds betting that the markets are going to fall.”
While the advice not to fight the Fed was generally sound in 2022, it occasionally ran into trouble when the bearishness started to boil over. This week’s advance came as Powell said Fed officials will not back down in the battle to contain inflation, boosting expectations that they will achieve a third straight rate hike later this month. A growing number of economists see a rise of three-quarters of a percentage point as the likely outcome.
Some cited the dollar’s retreat as another factor behind stocks’ resilience, as the recent currency market chaos is supposed to have put pressure on money managers to limit risk. Others pointed to the S&P 500’s own buoyancy as a catalyst for further gains.
At the center of the bounce is the 3,900 battle line, which acted as support in mid-May and then kept a lid on advances for a while in June and July. After managing to close above the range during a pullback on Tuesday, the S&P 500 began a three-day rally.
Along the way, the benchmark recovered other key trend lines, including the 100-day and 50-day moving averages. The Cboe Volatility Index fell for a second week in a row.
For rule-based traders, a calm market with favorable momentum is the green light to go far. Volatility-control funds, for example, snapped up $2.1 billion worth of stocks on Thursday alone, according to an estimate by Charlie McElligott, cross-asset strategist at Nomura Securities International.
As the market moved higher, it turned another set of price-insensitive players into buyers: options traders who took the other side of the derivatives trade and would have to buy or sell underlying stocks to maintain a neutral exposure to the market. During the week, they were mostly mired in a “short gamma” stance that requires them to follow the prevailing market trend, McElligott said.
Short sellers, whose bets looked prophetic during the 2022 bear market, were caught off-guard as stocks rallied. The need to cut losses forced a easing that led to an 8.2% jump in a basket of Goldman Sachs Group Inc shares. with most stocks shorted during the week.
Technically-driven demand defied the growing drumbeat of Wall Street warnings and overshadowed what is an increasingly bearish army of fundamental investors. This year, cash holdings have increased in mutual funds and hedge fund equity exposure has hit multi-year lows.
Now retail investors, one of the most fervent buyers in the post-pandemic era, are reconsidering their bullish stance. In the week through Tuesday, stocks sold off for the first time since June, according to an estimate by JPMorgan Chase & Co. derived from public stock market data. Meanwhile, more than $10 billion was withdrawn from equity funds, according to data compiled by EPFR Global.
“The bears will respond that the gains were only fleeting and were largely based on short covering,” said Michael Shaoul, CEO of Marketfield Asset Management. “While much of the Fed’s tightening has been priced into the market, the tenacity with which interest rates can be held higher in the face of a deteriorating economy has not been sufficiently accounted for.”
The whole year has been dangerous for both bears and bulls. As worrisome as all Fed policymakers sounded, inflation data due on Tuesday is likely to show prices softening from generational highs. And whatever damage rate hikes are doing, the damage has not yet reached corporate profits and the credit market.
Plagued by conflicting narratives, stock moves have made it nearly impossible to time the market. After suffering its worst first half in five decades, the S&P 500 recovered half of its bear market decline during a two-month 17% rally since mid-June. Once the rally hit a wall at its 200-day moving average in August, the index quickly reversed course and lost nearly 10% before rallying this week.
The whiplash prompted Suzanne Hutchins at Newton Investment Management to prepare for the unexpected. While he had reduced overall equity holdings in anticipation of an extended pullback, he recently bought bullish options as insurance.
“When you’re in a long-term structural bear market, which we think we probably are, you get very, very strong rallies in the market,” said Hutchins, senior portfolio manager and head of real return strategy at Newton Investment. “We have the call options up in the market if we’re wrong.”
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