Large market swings are more normal than investors might expect

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City on December 8, 2021.

Brendan McDermid | Reuters

The stock market’s wild swings over the past week have been an emotional roller coaster for investors, and the ride hasn’t quite stopped.

It hurts right now, and strategists say it could get worse as the market tries to find a bottom. Overall, there haven’t been many periods like this, where the Dow Jones Industrial Average swings 1,000 points in either direction, and stocks go up and down several percentage points in a day.

But strategists say big moves aren’t uncommon when indices are down substantially. In this case, investors are adjusting to a major change in the Federal Reserve. The central bank is moving away from its easy zero interest rate policy. This, in turn, caused investors to reassess valuations across the stock market.

“It’s a tussle and volatility is like blood pressure. It’s high when you’re scared, anxious, nervous and uncertain,” said Sam Stovall, chief investment strategist at CFRA. The first stocks to be hit were high-flying names that benefit from low interest rates, then the sell-off spread to other growth and tech stocks before encompassing the broader market this month- this.

According to Bespoke, the S&P 500 has had an intraday range of at least 2.25% every day for the past week. The major averages ended higher on Friday, erasing losses for the week, after pulling off another reversal late in the day.

For the week, the Dow rose 1.3%, the first positive week in four. The S&P 500 edged up 0.8% to 4,431 to end the week, and the Nasdaq Composite was flat.

Why the market was tough

“That’s what these policy pivots are for. In the early part of the economic cycle, the Fed is easy and growth picks up quickly. You have rising profits. You have loose monetary policy and you have incredible wind in the sails,” said Barry Knapp, research director at Ironsides Macroeconomics. “That’s what we had last year. But the Fed wasn’t supposed to let it go that long and it didn’t in other economic cycles, and that’s why it caused a violent reaction.”

Last week, the central bank made markets even more nervous when Fed Chairman Jerome Powell briefed the media. Powell acknowledged that the Fed could act even faster than the four rate hikes forecast by the markets for this year. The futures market immediately jumped to the price in five increases for 2022.


High, mooand closing levels for the Dow Jones Industrial Average

Graphic: Nate Rattner/CNBC

Source: Fact Set. As of January 28, 2022.

High, mooand closing levels for the Dow

Jones Industrial Average

Graphic: Nate Rattner/CNBC

Source: Fact Set. As of January 28, 22.

High, mooand closing levels for the Dow Jones Industrial Average

Graphic: Nate Rattner/CNBC

Source: Fact Set. As of January 28, 2022.

Michael Arone, chief investment strategist at State Street Global Advisors, said investors are also realizing earnings aren’t as strong as they used to be.

So far, 77% of companies are beating estimates for the fourth quarter, and they are posting earnings 4% above expectations, according to Refinitiv. This is well below the 16% average of the past four quarters, but in line with the long-term average.

“All of this leads to additional market volatility until investors digest this transition period,” Arone said. “On the other hand, the economy should continue to expand, earnings are pretty good. It’s enough to support the markets, but I think they are adjusting to the change in monetary policy, fiscal policy and profits.”

The wild swings are making investors even more nervous due to the relative calm of the past year.

Stovall said the normal average length between declines of 5% or more in the S&P 500 is 104 days, but in 2021 the S&P 500 lasted 293 calendar days before falling more than 5% in September 2021. Before that , the market had declined by more than 5% between September and November 2020.

What’s behind the movements

Knapp said when the market was in a lull, large investors used options and futures to hedge against a low-volatility market. The shift to a market that makes sudden moves forces them to change their strategy, and the process is partly the cause of the huge shocks in the stock market.

“When the street and the market makers are no longer short-term volatility, when they can’t afford to keep it because it’s way too expensive, the market makers are no longer there to cushion the blow , and that’s where it gets wild.” he said.

Knapp said investors will eventually hedge against a wider range of volatility and the market will calm down, but intraday moves will likely remain higher than they were.

Large swings are also correlated to trades around key market levels, such as those related to moving averages. The S&P 500 crossed its 200-day moving average last Friday, setting itself up for Monday’s sharp drop to 4,222 points. The S&P has bounced off this level, but strategists still view it as a possible area for the market to test before a bottom is set.

The 200-day moving average is considered an important momentum indicator. A drop below for an extended period suggests more downside, and a break above could indicate that a larger upward move is ahead.

“History is very clear on this, when you break through the 200-day moving average with conviction, like we did…whatever the cause of that breach, what usually happens is that you get a big drop of 10%, 12%, 15%, that’s what we got,” said Darrell Cronk, chief investment officer for wealth and investment management at Wells Fargo.

Cronk said in an interview on CNBC that the market is then set for a counter-recovery of maybe 4% to 7%. “A lot of times you get the true minimum from there, which means 10%, 15% extra,” Cronk said. “It happened in 2020. It happened in 2018. It happened in 2011. So I think investors just have to be a little bit careful here in the short term because the lows might not be hit yet with this type of fix.”

Cronk said he still expects stocks to be higher this year, but investors should be cautious now.

Rising rates

Stovall said a key metric to watch is the evolution of the 10-year Treasury yield, an important benchmark that influences mortgage rates and other lending rates. On Friday afternoon, it was at 1.78%, below its highs for the week. Yield also influences investors’ views on stock valuations.

Stovall said the 10-year rise suggests the S&P 500 price-earnings ratio may decline.

The price-to-earnings ratio is currently 21x on a rolling 12-month basis, down from 23.1% at the end of the year. This means investors are paying 21 times last year’s earnings. When the stock price falls, the price-earnings ratio also falls.

Stovall has studied what happens to this ratio when 10-year yields fall between 1.75% and 2.25%. He found that the high PE ratio was 19.7% during a period in 2019, but averaged closer to 16%.

“For us to move from 23.1% to the upper range of these observations, that implies a decline of nearly 15%,” he said.

What to watch

In the week ahead, investors will be watching top earners, such as Alphabet, Amazon and Exxon Mobil. Report from Bristol-Myers Squibb and Merck, as well as Ford and General Motors.

There is also key economic data, the most important of which is Friday’s January jobs report.

“Next week it will be interesting to see if investors celebrate bad economic news because of the implications for the Fed. Soon some of these numbers will include omicron impacts,” Arone said. “We’ve got data on manufacturing and services. We’re getting a lot of data on labor. As it starts to weaken and soften, will the markets be relieved as it will ease some of their concerns about an overly aggressive Fed tightening?

Calendar for the coming week

Monday

Earnings: Cirrus Logic, NXP Semiconductor, Helmerich & Payne, Cabot, Otis Worldwide, Ryanair

9:45 a.m. Chicago PMI

11:30 a.m. Mary Daly, President of the San Francisco Fed

12:40 a.m. Kansas City Fed President Esther George

2:00 p.m. Survey of senior loan officers

Tuesday

Earnings: Alphabet, Exxon Mobil, General Motors, UPS, Starbucks, Advanced Micro Devices, PayPal, Electronic Arts, Gilead Sciences, PutleGroup, SiriusXM, Chubb, Stanley Black & Decker, Pitney Bowes, Scotts Miracle-Gro, ManpowerGroup, Super Micro, PerkinElmer, Franklin, Genworth, Owens-Illinois, Ashland Resources

Monthly vehicle sales

9:45 a.m. Manufacturing PMI

10:00 a.m. ISM Manufacturing

10:00 a.m. Construction expenses

10:00 a.m. BLOWS

Wednesday

Earnings: Metaplatforms, Qualcomm, Novartis, DR Horton, Boston Scientific, Humana, Sony, AbbVie, Thermo Fisher, AmerisourceBergen, Capri Holdings, Marathon Petroleum, Avery Dennison, Johnson Controls, New York Times, Waste Management, Fortune Brands, TrueBlue, Netgear, Qorvo, Cognizant Tech, Suncor Energy, McKesson, Aflac, MetLife, Allstate, Spotify, Emerson Electric, T-Mobile US, Spirit AeroSystems

8:15 a.m. ADP job

10:00 a.m. Q4 Vacant dwellings

Thusday

Earnings: Amazon, Merck, Honeywell, Ford, Eli Lilly, Royal Dutch Shell, Check Point Software, Becton Dickinson, Activision Blizzard, ConocoPhillips, Biogen, Intercontinental Exchange, Snap, Estee Lauder, Lazard, Cardinal Health, Deckers Outdoor, Skechers, News Corp, Prudential Financial, Clorox, Illinois Tool Works, Ralph Lauren, Hain Celestial, Synaptics, Quest Diagnostics, Cummins, Roche Holdings

8:30 a.m. First unemployment registrations

8:30 a.m. Productivity and costs

9:45 a.m. PMI Services

10:00 a.m. ISM Services

10:00 a.m. Factory orders

10:00 a.m. Senate Banking, Housing, and Urban Affairs on Nomination of Sarah Bloom Raskin as Fed Vice Chairman for Oversight

Friday

Earnings: Bristol-Myers Squibb, Sanofi, Regeneron, Air Products, Aon, Eaton, CBOE Global Markets

8:30 a.m. Job report

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