“Good investors gather information, put that information into current and historical context, then make sound decisions.”
Last month we applauded a well-needed counter rally that arrived right on cue. June was a brutal month for equities with a mid-month, 6-day, 10%+ drop in prices that left no sector unscathed. It had all of the earmarks of a series of algo-trades, with prices dropping at the opening then flattening out the remainder of the day. Fortunately, it was short-lived and the counter rally started on the 17th of June. That started a rally that carried through all of July, and up to August 16th. In total it was a +18.8% run for the S&P 500 in two months. That rally positively impacted every equity market sector, as well as the bond market.
Counter rallies are positive moves that occur within the context of a longer-term downtrend. In this case the longer-term downtrend is medium-term, and the counter rally is short-term. The long-term trend is intact, going back for several years, with the most recent upward pulse stemming from the COVID correction the first quarter of 2020. Our current medium-term downtrend for equities started with the first of January 2022. This is the third counter rally we have seen in 2022, the first two being shorter, occurring in January and March. So why all of this discussion of trends and counter rallies? In an effort to reduce the drama and increase the science of market analysis. The more you understand the science, the less you ponder the mystery.
Financial markets ratchet up and ratchet down. Occasionally they will step onto express elevators going one way or the other, like last Friday. But, in general, financial markets ratchet their way along. Going back to last Friday, the 26th of August, yes, it was a significant move lower. No, it was NOT an algo-trade. Rather equity markets declined steadily throughout the day, not just in the first or last 10 minutes. The selling was disciplined, organized and spread evenly across the equity sector grid. It was a progressive, institutional sell program. This doesn’t lessen the significance, but it does help identify the players and their intent. Most importantly, there was ample room for the decline. Remember, the S&P 500 Index had rallied over +18% in two months. Friday’s -3% decline was manageable.
Granted, if you had just returned from a proper vacation with no media contact for a week or two, and then tuned in Friday at the close, it probably stirred some emotions. As of Friday’s close, the S&P was down 142 points, or -3.34% for the day, but was only down -1.62% for the month, and was up +7.45% for the quarter. The DJIA reports are always more dramatic, however, with the DJIA down 1,008 points for the day! That works out to -3.03% for the day, down -1.71% for the month, and up +4.90% for the quarter. Both of these indexes remain in negative territory YTD, with the S&P 500 Index down -14.00% and the DJIA down -9.97%.
Bond markets also had a counter rally that started mid-June and ran to the first of August. The rally in the Bloomberg U.S. Aggregate Bond Index (AGG) during that period was good for +5.90% over six weeks. But that’s where it ended, and in August the AGG has given up half of that move. The Federal Reserve is holding a tight rein on the bond market even as they are spurring short-term rates higher in an effort to catch up with the inflation rate. If that sounds complicated, it is! It’s a difficult task with a high-spirited horse, let alone the most powerful economy in the world.
Counter rallies are formative devices. They do not break or reverse more dominant trends all by themselves unless you are in a “V” recovery, and that ship sailed months ago. Rather, they are pieces of the puzzle that are useful in defining future trading ranges. Trendlines, moving averages, rallies and tests all factor into the process of building trading ranges. Trading ranges serve as bases for future breakout rallies, or ceilings for future price breakdowns.And it all starts with a counter rally.
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.