A Carefully Orchestrated Correction

“Good investors gather information, put that information into current and historical context, then make sound decisions.”

The S&P 500 declined for seven consecutive weeks in April and May before rallying last week. Those declining weeks may have appeared chaotic, but on examination certain patterns became evident. Although that seven-week period included some large individually negative days, on a weekly basis the declines were more moderate, even to the point of appearing to be choreographed. On a closing basis the weekly chart of the S&P 500 Index was contained within a narrow 2.8% channel. This price action was hardly random, but appears disciplined. This task would be all but impossible unless it was being orchestrated in concert by very large institutional investors. And this we know is exactly who is ‘runs the show’ in equity markets.

Another interesting detail is that this channeled downtrend touched, but did not close below the negative 20% decline that signals a Bear Market.  The S&P 500 Index opened the year at 4,766.18. A 20% decline would take it down to 3,812.94. The intraday low on Friday, May 20th was 3,810.32. Not a perfect score, but 99.95% accurate. The S&P 500 Index closed safely above that mark at 3,901.36. The following week the S&P 500 rallied +6.67% higher. Equity markets are not out of the woods yet, but the precision of that reversal was impressive and most certainly not an accident or random event. Institutional investors had no desire to hit those triggers, which would compel them to sell the market down much farther. At least not yet.

So why in the world would institutional investors want the market to sell down? The biggest reason would be because they are constantly investing new money and are constantly dollar-cost-averaging portfolios. This means that although their portfolios are also dropping when markets decline, they are regularly buying, and lower markets mean they are buying at lower prices, thus lowering their average cost. Imagine all of those 401k dollars pouring into the market every paycheck, no matter how high or low the market may be. Market declines are the hardest on static investors, such as retirees, who are not contributing with every paycheck any longer. They are invested in something all of the time, whether it is equities or bonds or cash. Their best options rest in careful asset allocations and all-enduring patience. Neither of them are easy. Both are critically important.

Additional proof rides with how specific equity sectors are performing in this correction. The investment darlings of this multi-year Bull Market have been in the technology sector. Thus far in 2022 the S&P Technology Sector Index dropped -27.37%. It rallied +8.23% last week. The S&P Communication Services Sector Index had dropped -28.11% before rallying last week. The technology-rich NASDAQ Composite Index has been white hot during this Bull Market, but had declined -30.60% during this year’s correction. It rallied +7.09% last week. Meanwhile, the S&P Energy Sector Index, which fell over -60% in the first quarter of 2020, is up over +60% in 2022.

Bond markets are finally getting a break as well.  The Bloomberg U.S. Aggregate Bond Index had declined by more than -10% YTD by early May, but has also broken its downtrend and initiated a rally. Like the equity market indexes, bond indexes still have a lot of work ahead of them. Unlike equity indexes, however, which can absorb the headwinds of rising inflation and higher interest rates, these fundamentals for bond indexes remain negative. That being said, bond markets had become significantly oversold. From a technical perspective, there is room for a relief rally in almost all bond sectors, including municipal and high yield bonds. Bond markets are not as easy to maneuver, even for institutional investors.

Once again, financial markets have a lot of work ahead of them. As we have said previously, we should not anticipate a ‘V’ recovery. If we do indeed have the beginning of a bottom in place for equities, excellent. It was of interest that last Friday every single equity index that we monitor was up. Perhaps the Friday jinx is over.   

Edward D. Foy, Manager, SELECTOR® Money Management, Chief Investment Officer, Foy Financial Services, Inc.

© 2022 Edward D. Foy.   [email protected], www.foyfinancial.com .

Sources: Bloomberg.com, Marketwatch.com, StockCharts.com, Morningstar.