by Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Company Ltd.
LIZ ANN SONDERS: Well, hello, everybody. Welcome to the May Market Snapshot. I wish I had better things to talk about these days, but as any market participant knows, it’s been a tough year so far, and it’s been particularly tough in the last few weeks. So that’s what I want to focus on today, is just the internals of market behavior, or maybe some of the messages emanating from what we’re seeing in the market.
So I’ll start with what I sometimes call a crowd favorite. This is a drawdowns table. I’ve shown it on these videos before. I put it on Twitter, maybe not every day, but probably a few times a week, and I think it’s an interesting look under the hood of the market. You’ve got standard market metrics like the S&P, NASDAQ, and Russell 2000 indexes. You can look at things like the year-to-date return. What you see, not pretty numbers, certainly, not in the case of the NASDAQ and the Russell 2000, which are down more than 20% from their year-to-date high. But I think it’s some of the columns to the right that are a bit more interesting, and this is the under the hood analysis.
So the left three columns there, other than the indexes, that corresponds to year-to-date, actually, four columns, so that’s a year-to-date section. And then the three columns to the right of that are a one-year section, so 52-week time span.
And I think some of the more interesting columns, I now put red boxes around here, which instead of looking at what the declines have been for the indexes at the index level, let’s look at the members of each index, if you took an average of all the members, and, for instance, looked at the average maximum drawdown across the members. Here you see numbers that are a bit more dire, both on a year-to-date basis and the past 52 weeks. So in the case of the S&P 500, which is not yet seen as in a bear market using the traditional down 20% from a high, at the index level, you could argue is in a bear market at the average member drawdown level—minus 23% in the case of from the year-to-date high, 27% from a 52-week high. And, again, the numbers look even more severe for the NASDAQ and the Russell, both relative to year-to-date highs as relative to past 52-week highs.
Now, if there’s any good news that comes from this analysis, think back to points last year, where I was showing this, talking about it, put it in my writings, and my thesis at the time was this underlying weakness had the possibility of creeping up to index level weakness, especially if some of the big stocks in these indexes, the FAANG-type stocks, started to get hit, that you would see the indexes catch down to the underlying weakness. The fact that has started to happen and the underlying weakness is even more severe, that suggests that even if all the damage hasn’t been done, a lot of damage has been done under the surface. So I just wanted to try to put at least a relative bright spot on what is otherwise a pretty gloomy table.
Also, on Twitter, often I show these moving average breadth charts. It’s the same indexes here, the S&P, the NASDAQ, and the Russell. Each one is color coded there, and this just looks at the percentage of stocks that are trading above their 50-day moving average and their 200-day moving average. 50- on the left, 200-day on the right. And you can see we’ve had fits and starts throughout the course of the last year, but now we have sunk to depths pretty much as low as we have been since the pandemic COVID lockdown era bear market of 2020. We can also look at the sector level, and here’s where things have changed more recently. For quite some time, until really a couple of weeks ago, energy, which has been the best performing sector over the past year, was up around 100% of its stocks trading above those moving averages. You can see that’s still the case relative to the 200-day moving average, but we’re now at less than 50% of even energy stocks are trading above 50-day moving averages. This also suggests a tremendous amount of damage has been done.
What’s also of note here is what I often call the growth trio—technology, consumer discretionary, and communication services. You can see those three sectors to the left of these bar charts. That’s where the damage has been most severe. We saw last year’s weakness, again, creep up the cap spectrum, start to hit some of these benchmark household tech and tech-related type names. And I think one of the primary drivers for that is this is where valuations were most rich, and in this rising interest rate, rising inflation environment, that tends to put downward pressure on growthier segments of the market, segments of the market where valuations have been more rich. So that’s why you see much more damage across that spectrum, where you see much less damage among some of the classically defensive areas like utilities and consumer staples, and I think that’s indicative of the point in the cycle that we reside.
We’ve also seen a lot of day-to-day volatility, big swings in the market, outsized moves, both on the up side and the down side. This is a long-term look, back to 1970, at the distribution of returns on a daily basis, and you can see most of them are clustered in fairly mild moves, really, less than 1% kind of moves is the norm. But just last week, we actually saw back-to-back days that were on the tails of this historic distribution. We had the big Fed rally, Fed day rally, that occurred on May 4th at just about a 3% up day, and then the very next day, on May 5th, we had a 3.6% down day. So that’s an incredible swing, so you can just get a sense of the day-to-day volatility with which we’re dealing and I’m not sure this changes, at least in the near-term.
Now, it’s also a mid-term election year. That’s not been a huge focus for, I think, market participants in light of the weakness in the market. There are patterns, historically, that suggest somewhat weak performance in mid-term elections year, typically until about the, you can see here, 38 weeks or so, and then you tend to see a rally. But I’d be really careful about applying any analysis associated with market patterns in mid-term election years, because I now want to show you what this year’s stock market has looked like, relative to that norm. That doesn’t mean we might not ultimately see an outsized version of this pattern, but we’re already bucking that somewhat typical seasonal pattern, so I wouldn’t put a lot of weight on the possibility of the market rebounding solely because of the election cycle patterns of the past.
Now, when I had that drawdowns table up, I tried to find the silver lining associated with that, and here I want to add another potential silver lining in terms of just how much weakness we’ve seen in the market already to-date. Now, as many viewers of these videos know, or if you read my work, or follow me on Twitter, you know that I spend a lot of time focused on investor sentiment, and as many investors know and many market watchers know, investor sentiment at extremes tends to be a contrarian indicator. Now, it’s not a perfect market timing tool. It’s not the case that if sentiment gets very pessimistic, that that’s an automatic buy entry point for the market or vice versa, but what it does is it establishes the conditions maybe for a counter move to sentiment if a catalyst presents itself, and this is one measure of sentiment. I call this an attitudinal measure of sentiment, because it’s survey-based. It’s the AAII weekly survey of their members. It’s a survey that encompasses tens of thousands of investors. And the question simply is are you bullish, are you bearish, or are you neutral? And you can see, we recently hit about a 14% bullishness level. The last time we saw anything that low, you have to go all the way back to 1992, so this is an extraordinary amount of concern that has come into the market. Now, again, this is not by any means a perfect contrarian indicator, but it does establish the possibility, if there is some sort of positive catalyst, that we could maybe see a larger move back on the upside, a bounce, because of how washed out sentiment is.
There’s a rub, however. As I mentioned, this is an attitudinal measure of sentiment. We can also look at behavioral measures of sentiment. So I like to think of this as what are investors saying, represented here, what are investors doing, sometimes very different. And that’s what we’re seeing here. This is the put-call ratio, the equity-only put-call ratio. When the reading is very low, like it was for a good part of 2021, that means that there’s a tremendous amount of optimism, much more focus on call buying in the options market. That’s a bullish strategy. When you see it move significantly higher, like was the case in the March 2020 period of time when we had that COVID bear market, that reflects a tremendous amount of pessimism because of more put buying relative to call buying. Now, you can see we’re up from 2021’s lows, but nowhere near the kind of spikes that we’ve seen historically, spikes that tended to correspond with near-term bottoms in the market. You see the big one, again, in March of 2020, but you can look at similar spikes in 2016, back in 2011, and then, of course, several times during the latter part of the global financial crisis. So I think a bit more work may have to be done here to get that sense of capitulation, the washout.
Another thing we can look at are fund flows. This, in particular, looks at exchange traded fund flows, domestic, meaning U.S. equity ETFs. That’s where most of the action in the market has been. And you can see a huge surge in flows into domestic equities in 2021, really, into the very beginning of 2022. Those have started to roll over. I would expect more damage to come here, more capitulation, more selling to finally get a sense that sentiment in its broadest sense, both attitudinal measures and behavioral measures, has gotten to that washout point. It doesn’t mean we might not have some of these counter trend rallies along the way. And that is part of the reason why you never want to take an all-or-nothing approach to investing. As I always say when I get the question, often from the media, are you telling investors to get in or get out? My answer is always, well, neither get in nor get out is an investing strategy. All that is gambling on specific moments in time, and investing should never be about specific moments in time. But we can generally get a sense of whether the market has started to look washed out, at least based on how sentiment contributes to market action.
Finally, on the volatility index, sometimes called the fear gauge, another metric that sort of measures behavior in the market and shows often when we’ve hit an extreme in volatility. And you can see volatility can stay very low for extended periods of time, then the spikes happen. The good news is that they tend to be short-lived spikes, and then they ease. Again, we’re up off the recent lows, but nowhere near the spikes you would want to see to get a sense of that washout.
So I’ll go back to what I just said, all-or-nothing investing, quite frankly, doesn’t make a lot of sense. It’s gambling on moments in time. To get out and get back in requires perfection in the timing decision two different times, and we would never suggest investors try to do it. But I also know we want to get a sense, and that’s what we’re here for, about whether we are seeing the kind of washout capitulation in measures like sentiment that maybe a point where we’ll either see some counter trend rallies, or we’ve seen a lot of the most negative action already in stocks.
My net sum of where we sit right now is the market with its weakness has discounted a lot of the negativity that we’re seeing right now, certainly a lot of the slowdown in the economy. However, if a recession is going to befall the economy, and I think there’s a decent risk that that happens, there probably is a bit more downside to go in the market. This is not a time for excessive risk-taking, but use volatility to your advantage. Just remember disciplines around diversification and rebalancing. There’s no free lunch in this business, especially in very volatile times, but some of those disciplines can represent that sort of anchor to windward that helps at least ride through difficult periods a little bit more smoothly.
So thanks as always for tuning in, really appreciate it.
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