Needless to say, you probably shouldn’t trust Wednesday’s monumental rally in U.S. equities.
That’s not an attempt to throw cold water on the best session since 2009 as much as it is a realistic assessment of the current environment.
There’s nothing “normal” about what transpired on Wednesday and the fact that a 5% rally played out on a day when the Richmond Fed collapsed the most on record speaks volumes about the extent to which the market is marching to the beat of its own drum. It’s ironic, too, because the narrative over the last three or four weeks has revolved around the idea that the selloff is overshooting economic fundamentals and Wednesday was the exact opposite of that – the Dow surged 1,100 points while the shipping subcomponent in the Richmond survey plunged to its lowest in nearly a decade.
It’s also interesting to ponder the prospect that investors might have written off the “Fed put” at the exact moment it went into the money. We talked about that at length on Wednesday morning.
Common sense dictates that trying to get a “clean” read on things during the trading days between Christmas and New Year’s is an exercise in futility. Additionally, it seems entirely likely that some folks were forced buyers into the close on Wednesday, supercharging the rally.
In any case, we wanted to highlight a couple of excerpts from the latest note by Goldman’s Rocky Fishman. Long story short, there’s good news and there’s bad news.
The bad news is that liquidity continues to be abysmal. “Although high volatility and the holiday season are contributing factors, SPX E-mini future top-of-book depth has continued to weaken”, Fishman writes, adding that on Goldman’s estimates, “the median bid/ask depth of the front-month E-mini SPX future was $1.7mm notional on Monday, 24-Dec, [just] around 1/4 of the $6.7mm on 23-Nov, the last holiday-season short session.”
He also observes that “Friday’s SPX futures/options settlement, had one of the larger gaps between the settlement value and front-month futures prices in recent years.” Here’s an updated visual from CME’s E-mini liquidity tool:
The good news from Fishman is that a close historical parallel to the current environment suggests stocks could rally and volatility could come back in sharply.
“The contrast between Q3’s 6.5% realized vol and Q4’s sell-off is similar only to the contrast between 1962’s Q1 (7.4% RV) and Q2 (-21% return)”, he writes, on the way to noting that “although vol remained slightly elevated as the market rallied in the remainder of 1962, the SPX followed Q2 with eleven consecutive up-quarters, six of which remain the least volatile quarters in the index’s history.”
Anything’s possible, I guess. Although since the S&P technically skirted a bear market with Wednesday’s surge, a repeat of the 1962 experience that sees the index rally for another eleven quarters suggests that by the time this bull finally dies, some of the traders who started their careers just after the crisis will be pushing 40, a hilarious prospect that speaks to, well, it speaks to a lot of things.
Anyway, Goldman also notes that the S&P’s Q4 return is among the worst ever.” Specifically, it’s in the 3rd percentile since 1929.
We’re gonna need more Wednesdays.