After more than a year of futility, short sellers just scored their fifth straight week of positive returns, their best run since 2018. In another development that has portended trouble in the past, individual stocks have started moving around in unison, a sign of shared anxiety that has pushed realized correlations to the highest in a year. At the index level, swings in the S&P 500 topped 1% for six straight sessions through Thursday, the longest run of volatility in six months.
Alone, none of the developments is conclusive, and equities have certainly shaken off worse en route to doubling since Covid-19 broke out. But together, they hint at a shift in psychology tied to evolving policy at the Federal Reserve, whose trillions of dollars of stimulus spending is finally poised to taper off. On top of this, raging commodity inflation and persistent supply chain disruptions are threatening corporate earnings.
Rising correlations are “a sign of market fragility — you could see a market pullback if there’s a change in outlook,” Steve Kolano, chief investment officer at BNY Mellon Investor Solutions, said by phone. “There’s a lot of mixed currents in the market right now.”
Stocks took one of the year’s more circuitous routes to an advance this week as oil and natural gas producers surged amid an energy crisis in Europe and China. All along, though, violent moves rattled traders.
With corporate earnings yet to start, stocks were hostage to the ebb and flow of macro headlines. The newfound tendency to move in lockstep contributed to some big reversals, including Wednesday, when the S&P 500 erased a 1.3% intraday decline. That was the biggest turnaround since February, spurred by Republicans saying they were ready to offer Democrats a way to end the debt limit impasse.
“We went through a period when there was no volatility in the market, there weren’t these big up-and-down days,” said Barry James, portfolio manager at James Investment Research. Now, “people have to get a little afraid of the market before you can really form that bottom and take off again.”
Bears, driven almost into extinction amid the relentless equity rally and January’s retail-fomented short squeeze, are staging a comeback. In September, when the S&P 500 had its worst monthly drop since March 2020, hedge funds boosted short sales at the fastest pace in more than two years, according to data compiled by Morgan Stanley’s prime broker.
For once, those bets didn’t immediately implode. A Goldman Sachs Group Inc. basket of the most-shorted stocks dropped almost 4% over past five days to the lowest level since May, ringing up gains for short sellers who borrow and sell shares hoping to buy them back at lower prices.
To bulls like JPMorgan Chase & Co. strategist Marko Kolanovic, all the worries about surging energy prices and interest rates are misplaced. As he sees it, the economy is on pace for a sustained recovery now that the Covid trend has improved. Kolanovic has a model showing stocks should be fine even if oil climbs to $130 a barrel and 10-year Treasury yields hit 2.5%. Crude futures recently hovered near $80 and 10-year yields stood at 1.6%.
Rick Rieder, the chief investment officer of global fixed income at BlackRock Inc., agrees stocks can keep going higher, though he cautions the prevailing macro-economic uncertainty means investors need to temper their optimism.
“Some of what we’ve seen today play out and we’ve seen over the last few weeks, does mute a little bit of where the near-term upside is,” Rieder said on Bloomberg TV with Jonathan Ferro while discussing Friday’s payroll miss. “When I read corporate earnings reports and I see, ‘Gosh, we can’t get enough product in, we’re having a hard time getting labor in,’ it does mute what was on the way to being explosive earnings growth, explosive top-line revenue growth.”
Indeed, bulls are retreating while the drumbeat of warnings is getting louder. The proportion of newsletter writers classified in Investors Intelligence’s survey as being in the bull camp tumbled to 40.4% this week, the lowest since March 2020, data compiled by Yardeni Research show. Meanwhile, those calling for a market correction jumped to 37.1%, the highest over the same stretch.
To JJ Kinahan, chief market strategist at TD Ameritrade, all the bearishness sets the stage for a bounce back and one big risk for investors is getting out too early.
“Every person who’s called the top over the last 18 months has been carried out on a stretcher, if you will,” he said by phone. “I think it’s the time to be cautious — I don’t know that it’s the time to say ‘yes, this is sell time.’”