Where Will The Market Go Next?

No idea – now that we have gotten that out of the way it is interesting to look at two competing narratives that have arisen as a result of last night’s action on U.S. markets. The first interpretation is given by the table below which looks at the performance of the S&P 500 post any day where it gained more than 5% you can see that at the one year mark in the majority of occurrences the performance is positive.

Source – @RyanDetrick

You will notice around the GFC when there were several days of extreme performance on the S&P 500 the subsequent performance of the index was quite mixed. This sort of data is being presented as evidence that the market has hit some form of bottom and that moving forward we can expect returns from the market to be positive. As I mentioned in last week’s market wrap the short-term structural elements of the S&P 500 were positive however they are short-term elements. We won’t really know what to make of last night’s extreme move until we look back in this time next year. The second narrative is that this is merely a massive short squeeze and that what has happened is that inflation numbers coming in at shall we say less worse than expected triggered a buying frenzy of short covering this short covering fed on itself. The gist of this argument is that such a rally is short lived and as evidence of this proponents point to the difficulties the market had following through on these very large days during the GFC.

What I find interesting is that both narratives can be true we can hold both these thoughts in our head at the same time they’re not necessarily binary in nature despite being presented as such. The tendency to present arguments as binary is a function of the adversarial nature of the way people view markets. There is a lack of understanding that markets are fluid in their movement and therefore there will be times when paradoxically all points of view are correct.

However, this brings me back to my opening sentence I accept that when we look back at history on the majority of occasions the market is higher. However, that’s presented as an endpoint in no way does it give an indication of what the trajectory of that endpoint is it gives no indication of how we get there. For example, it is quite possible that last night’s rally was merely a short squeeze the market falls away and gives back the gain of last night but one year hence is positive once again we are confronted with the paradox of both arguments being true.

This highlights the danger of narratives in attempting to generate any form of trading strategy or actionable idea from this sort of data. Whilst this sort of data is an interesting journey into history it doesn’t present you with a workable trading idea. Trading ideas come from the analysis of price action as it unfolds.