Don’t you just love this game? The very moment the price action begins to make sense – bam! – Something happens that causes traders to reverse course in a big way, leaving many scratching their heads in the process.
Of course, I’m referring to the decline in the S&P 500 seen over the past couple of weeks versus the spirited bounce on Monday. If you will recall, the excuse du jour for the latest pullback in stock prices has been the worries over global growth. So, after a series of gruesome attacks in Paris on Friday, why did the S&P 500 spike higher 1.5% on Monday?
Some will argue that stocks had become oversold and the decline had been overdone to the downside. Therefore, Monday’s rebound was merely the latest in a long string of mean reversion moves – meaning that it was simply time for traders to go the other way again (or at the very least, cover some shorts!).
S&P 500 – Daily
While I am hesitant to ever argue with what Ms. Market does or why, I have a theory that, at least in my feeble brain, seems to make some sense.
First, let’s start with the understanding that traders tend to have their fancy computer algorithms tied to something. Remember, computer algorithms are really just a massive series of if-then statements. For example, if XYZ moves down, then computers are programmed to automatically sell SPX futures and vice versa. Then once a move gets started, the trend-following algos jump onboard. And before you know it, the stock market has moved 1% on the day – again.
The trick is to figure out what the triggers for traders are. I.E. what exactly are they focused on? And while I could very well be out in left field on this one, it looks to me that traders are tying their equity trading right now to the price of oil.
On the surface – and prior to Friday afternoon – this concept makes some sense. Since oil is a poster child for the “issues” surrounding global growth and global growth is indeed the focal point of the market, then one can avoid reading all those economic reports and cut to the chase by simply buying and selling stocks based on what oil is doing.
Think I’m nuts? That’s certainly your prerogative! However, compare the price action of the S&P 500 from October 27 on the chart above to that of the USO shown below. It will suffice to say that when oil has gone up, stocks have followed suit. And when oil went down, well, you get the idea.
U.S. Oil Fund (NYSE: USO) – Daily
But back to reality here for a moment. I’m imagining a great many investors are wondering why on earth stocks would go up the first day after a terrorist attack and the first day after a new “war” had been announced? After all, don’t stocks usually fall in these types of situations?
First off, let’s recognize that from a fundamental standpoint, this particular war – disturbing as it may be on an emotional level – isn’t likely to have much of an impact from an economic standpoint. So there’s that.
But for those traders following oil around like a little puppy dog, the game didn’t require much thinking on Monday. Oil bounced right where it needed to and enjoyed a nice gain. So naturally, stocks followed suit. Because, well, that’s what they’ve been doing. But the rub here is the reason oil bounced would appear to make this particular correlation trade a bit confusing.
To be sure, oil almost always moves higher when “geopolitical issues” arise. And with French and U.S. war planes dropping bombs and drones killing terrorist leaders in the Middle East, it wasn’t surprising to see a “risk premium” applied instantly to the price of oil. You see, there is always a risk that some nitwit and their hand-held rocket launcher will interrupt the flow of oil.
Furthering the argument that Monday’s move did not represent a change in sentiment toward global growth was the action in copper. Yep, that’s right, Dr. Copper fell again on Monday – this time by -1.8%.
Ipath Copper (NYSE: JJC) – Daily
So, from my perch, it would appear that while stocks did indeed sprint higher on Monday, they may have done so for the wrong reasons. But then again, I could always be off my rocker at the moment and misreading the situation! Time will tell. But given that the market had been focused on global growth fears, I thought it was a theory worth exploring for a few minutes.