Investors Are Speechless: "It's Like Watching Pulp Fiction"

With market action becoming increasingly surreal and the panicked, vertigo-inducing bear market rallies (spawned by a record $64 billion pension fund reallocation into stocks in a historically illiquid market) reminiscent of the chaos observed at the depths of the financial crisis, it is only appropriate that some of the quotes Bloomberg picked for its daily wrap piece which commemorated the biggest intraday reversal since 2010, be just as surreal.

"Investors are becoming desensitized," Bryce Doty, SVP at Sit Investment Associates, told Bloomberg, then continued the verbal poetry: "It’s like watching ‘Pulp Fiction.’ Halfway through, the violence doesn’t even bother you anymore."

He's right, although whereas the market "violence" in past weeks was one directional, this week it has developed a twist to trap both the bulls and bears, and while the latest Dow swing (of nearly 1000 points) was only slightly bigger than the average up-and-down move last week, back then equities were merely tumbling, now it tends to drop early in the day then soar in afternoon trading. So fast forwarding to the post-Christmas chaos - which this website explicitly warned about when last Friday we said to "Brace For Seismic Volatility" - strategists are starting to ask: if days like these are now normal, is there a context in which the whole three-month rout starts to feel routine?

There are the optimists like Jim Kelleher, director of research at Argus Research, who said market turmoil that happens when the economy is holding up reminds him of past stock declines that ended gently.

Unless evidence emerges of deep global growth erosion, what’s going on now “will prove to be shorter and more shallow than the declines experienced in ‘classic’ bear markets.”

Others are not so sure: "Investors are wondering if this will be a crash,” said Dave Campbell, a principal at San Francisco's BOS, who nonetheless still managed to put a favorable spin on events.

"The risks are there, but they’re always there. They’re more heightened but it’s not the most likely outcome. The economy continues to grow - maybe a little more slowly - but next year markets will have hit their lows and we’ll be on the rebound."

Then there are those who echo what we asked yesterday, namely if this is only a bear market rally, although granted a very furious one: as Bloomberg writes in its second end of day wrap, "on the surface, the rally is good news for investors searching for a bottom after a three-month sell-off sent the S&P 500 to the brink of a bear market. But days like this are rarely good omens."

Here's the problem: as we discussed last night, since 1990, every comparable reversal - with a few exceptions - came during the 2008-2009 bear market.  According to Bloomberg data, in eight previous bear markets the S&P 500 experienced rallies of greater than 2.5% more than 120 times as the benchmark plunged from peak to trough. From the collapse of Lehman to the financial crisis bottom in March 2009, the S&P 500 rallied more than 4 percent on 13 different occasions.

"This is not the kind of price action you see in normal bull markets,” said Robert Baird equity sales trader Michael Antonelli. "This is just a face ripping short cover rally. I am 100 percent not saying we are in a situation like 2008 now, but look at October 10, 2008 to October 13, 2008: the market rose nearly 12 percent in one day. October 27 to October 28, 2008, it rose 11 percent."

In other words, as Bloomberg notes and as Antonelli said yesterday, much as the market has shown the impetus to rally, "violent action like this normally don’t bespeak a healthy market." The latest bounce happened during a holiday week when prices are typically susceptible to swings because of low liquidity, which in the context of the ongoing $64BN pension rebalancing, makes sense that we would see a massive swing higher as the market at times goes offerless.

Jeff deGraaf, co-founder of Renaissance Macro Research, may have summarized trader sentiment best:

“How much do we trust the market’s message, up or down, over this holiday week? About as much as we trust uncle Albert to drive home after Christmas dinner.”

And speaking of a Pulp Fiction market, at least there is no friction as investors are now getting used to the daily whiplash: Thursday marked the ninth time this quarter where the S&P 500 reversed an intraday move of at least 1%. That’s the most since August 2011, when S&P downgraded the U.S. sovereign rating, sending stocks also within points of a bear market.

Which begs the question: having failed to firmly enter bear market territory, are we in a bear market or is this merely a violent correction? According to Argus research, bear markets that go way past 20% tend to be associated with “secular transitions,” things like the excessive valuations of the dot.com bubble. Near-bear markets, however, are more common around technology transitions or one-time disruptions. The one taking place now is perplexingly occurring next to high consumer and small business confidence, solid industrial activity and low interest rate and energy inputs.

There is another silver lining to the current constant whiplash: even in a worst case scenario,"only" half of the 14 bear markets that took place since World War II occurred during a prolonged economic contraction, LPL Research showed. Sell-offs when the economy contracts are bad, see the S&P falling 37% on average. The ones that come when growth is positive level off at 24%.

“In the end, the largest market corrections take place during recessions. Will we have a recession in 2019? We don’t think so,” LPL's traditionally cheerful Ryan Detrick told clients. "The bottom line is that you can have bear markets without a recession."

Which, of course, is bad news if the violent rally of the past two days is indeed only due to a massive pension reallocation trade, as the "bad" kind of bear market lasts an average of 556 days and is much worse than 20%, according to Argus. The mean peak-to-trough decline during recent bear markets has been around 35%.

Alternatively, if stocks are indeed trying to find a bottom and can reverse their recent downtrend, the current "bearish duration" would be short, at less than 90 days.

Until we know for sure, better strap in... or is that strap on?