Upside Down(side): Markets' Wild Rides

Last week's strength in the equity market helped pare year-to-date returns. After suffering a near-bear market drawdown of 19%, the S&P 500 is down 9% as of Friday's close. It's been worse for other indexes and groups, like the Nasdaq and Mag7 (Lag7) group of stocks, as shown below. After a strong start to the year through February 19, bear market level declines set in (although for the S&P 500 it was only a close call).

Trying to trade this rampant volatility is a tricky game, especially given that the correlation of movements within an index like the S&P 500 has gone parabolic, meaning the majority stocks within the index are generally moving in the same direction. This phenomenon makes it more difficult to separate winners from losers. As shown below, at the mid-February peak in the index, the rolling one-month correlation was near zero. As the index began to fall, the correlation started to rise (which is common), before shooting to the moon following the "Liberation Day" tariff announcement.

Most notable last week was last Wednesday's epic surge in stocks, which helped to calm investors' nerves. The 9.5% single-day jump in the S&P 500 was the third-largest in the post-WWII era. We highlight in the table below, that among the list of all daily moves of at least +5%, more of them occurred within bear markets (14) than in bull markets (10). Per the bull market big up days, notice that some of the largest daily gains in stocks came somewhat immediately following bear market lows and/or major corrections (2022, 2020, 2009, 1997/98, and 1970).

Bad breadth

The recent rout in stocks has led to a significant washout in market breadth, with major indexes seeing the percentage of their members trading above their 50-day moving averages sink quickly. As shown in the chart below, that metric for the S&P 500, Nasdaq, and Russell 2000 fell into single-digit territory at the worst point of the current drawdown. The drop for the S&P 500 was much more severe, underscoring investors' willingness to shed even their high-quality holdings as the global trade war unfolded.

The upside is that, like with investor sentiment, once breadth gets this weak, it indicates a "reset" of sorts—allowing stocks to regain their footing (see the end of 2024 as an example). The downside is that a clear catalyst is needed to jolt stocks into recovery mode. To be sure, some catalysts—like the 90-day pause for aggressive reciprocal tariffs and the exemption of smartphones and laptops—have started to pop up, but they aren't necessarily doing a lot of work to eliminate the thick cloud of uncertainty that still hangs over the market.

That is emphasized via sector leadership. As shown in the chart below, traditional defensives like Consumer Staples, Utilities, and Health Care have fared well when it comes to the share of members trading above their 50-day moving average. Even more of a standout is Utilities' share of members trading above their 200-day moving average (at nearly two thirds).

The resilience in defensives' breadth has been consistent with their outperformance since the S&P 500's all-time high back in mid-February. As shown in the table below, Consumer Staples, Utilities, and Health Care are at the top of the leaderboard—respectively—since the market's peak. At the opposite end is the "growth trio" of Information Technology (Tech), Consumer Discretionary, and Communication Services; all of which suffered bear-market level declines during the "crush" period between February 19 and April 8.

Anatomy of a rebound

Breadth statistics make it clear that indexes are at or near washout status, but in order for a durable rebound to take shape, defensive leadership likely needs to take a breather—or rather, traditional cyclicals (like Financials, Industrials, and Materials) need to reclaim some lost footing. We think that would send a positive signal that the market is regaining some confidence after being hit hard from tariff volatility, but we also think this continues to be a low-conviction environment.

Trying to gauge sector moves and leadership shifts is nearly impossible right now, especially as the rules of the U.S. tariff and trade game seem to change on almost a daily basis. Given that, we have neutralized our sector ratings, bringing all 11 S&P 500 sectors to "market perform" (neutral). The last time we implemented this kind of change was during the depths of the pandemic. While we are in a confidence crisis, not a health (or financial) crisis, the degree of volatility we're seeing—be it in the VIX, MOVE or Economic Policy Uncertainty Index—rivals what we saw in 2020.

Factors at play

We continue to emphasize that investors should continue to take a factor-based approach as a way to navigate volatility within the equity market. Screening for high-quality companies or industries is one of the best ways to play defense these days. Low volatility, low beta, high interest coverage, and stable profit margins are among the characteristics that have fared well in this recent bout of turbulence. While those factors might underperform when tariff relief/delay news hits the newswires and gives a lift to markets, those high-quality factors should remain outperformers when the opposite occurs.

The reality is that this current environment is being dominated by man-made supply shocks unlike anything seen in the past century. However, it's crucial to avoid making assumptions (economic or market) based on recent trends. Although the current policy landscape and related economic uncertainty more than justify the recent spike in volatility, be mindful of not interpreting short-term market moves as anything resembling clear signals of where we go from here either in the economy or markets. Many of these extreme moves are simply the result of technical break points (in both directions) associated with a wide variety of stressed positions and their unwinds.

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