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Get used to Wall Street’s churn and mini-cycles: McGeever

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ORLANDO — The whiplash on Wall Street following the latest U.S. inflation figures should be a warning to investors: get used to it, because there will be plenty more in the months ahead.

There’s a growing belief that the downturn in equities that broadly spanned the first half of the year is being replaced by a more volatile, foggier period of ‘mini-cycles’, which will see bouts of gains or losses suddenly evaporate and reverse.

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In some ways, bonds, interest rates and currencies are playing the Fed’s inflation-busting hawkishness pretty simply – implied U.S. interest rates, short-dated yields, and the dollar are generally climbing to historic highs, often at unprecedented speeds.

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But stocks could have a harder time forging a clear path. Until the economy tips over or the labor market significantly and clearly deteriorates, a low-growth but non-recessionary environment can keep earnings estimates buoyed for longer.

While bonds and currencies tend to move earlier, equity investors are notoriously late to blink.

Tuesday’s carnage is instructive. The S&P 500 and Nasdaq Composite indices plunged after the punchy August inflation report ramped up already aggressive expectations of Fed tightening.

The S&P 500’s 4.3% slide wiped out most of its 5% rise over the previous week. That had followed a decline of around 10% over the previous three weeks, which had followed a rise of almost 20% over the preceding two months.

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That was the S&P 500’s eighth daily fall of 3% or more this year. In the last 70 years, there have only been three that have registered more declines of 3% or more – 2008, 2009 and 2020.

The Nasdaq’s 5% fall on Tuesday marked the seventh time this year it has dropped 4% or more. It fell that much on 10 occasions in 2020, but not once last year, and only three times from 2012 through 2019.

Stephen Miran, co-founder at Amberwave Partners and a former economic policy adviser in the Treasury Department, says this is a period of range trading, but one where the upper and lower limits of these ranges will be tested more quickly, frequently, and violently.

“This isn’t a ‘buy and hold’ or a ‘short and hold’ environment. This is a time to be nimble and recognize that active management and willingness to quickly flip between long, short, and flat is key,” Miran said.

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“The signposts for these mini cycles will be high-frequency economic data, like (the August) CPI data,” he added.

MIXED SIGNALS

Miran reckons the upper end of the S&P 500’s range is 4300-4400, and the lower end is 3600-3700.

That represents a roughly 20% peak-to-trough range. That is also the range in which the index has bounced around over the last three months, since the 18-month low was hit in mid-June.

What’s compounding investors’ lack of visibility is the fog of contradictory signals from key earnings, technical and positioning indicators.

It is true that valuations of S&P 500 companies, according to a standard 12-month forward price/earnings ratio for the index, have come down sharply this year. But they are still above long-term averages.

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Earnings estimates, meanwhile, are historically low, but are still pointing to 7% growth next year.

Bank of America’s latest fund manager survey showed that while investors’ allocation to global stocks is at an all-time low, only 4% are net underweight U.S. stocks, by far the least bearish of all regions.

Analysts at JP Morgan say the signals from commodity trading advisors and other momentum accounts’ positioning are only “modestly” short, and remain some way off the “extreme” levels of mid-June. This suggests the door to further downside remains open.

These investors, including hedge funds, are more flexible than more traditional long-only or passive funds. According to hedge fund data provider HFR, macro funds – which latch onto broad market swings and trends – were up 9% in the January-August period, while the benchmark hedge fund index was down 4%.

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But U.S. equity fund inflows over the last six months or so have totaled around $100 billion, and some $300 billion since July last year, according to Goldman Sachs. The air in that particular balloon is unlikely to be sustained.

What’s more likely, as Bank for International Settlements chief Agustin Carstens and the European Central Bank’s Isabel Schnabel highlighted at last month’s Jackson Hole economic symposium, is that volatility remains elevated. This could lead to more violent swings within broad ranges.

In the decade through March 1, 2020 – just before the start of the coronavirus pandemic – the daily mean of the S&P 500’s simple 14-day momentum indicator was just over 12. So far this year it is almost -55, and the trading range reflected by 1 standard deviation from the mean is also around four times wider.

(The opinions expressed here are those of the author, a columnist for Reuters.)

Related columns:

Market bunkers getting mighty crowded (Sept. 14)

Markets wary of overstretch as much as overshoot (Sept. 7)

RIP Great Moderation, hello Great Volatility (Aug. 30)

(By Jamie McGeever; Editing by Paul Simao)

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