Although the move in the indices on Thursday was the narrowest in several weeks, it was the best price action in a while -- and suggested that a much-anticipated countertrend bounce was ready to gain traction. As I discussed, the better action in small-cap stocks was the main tipoff that some of the recent fear and uncertainty had diminished.
The bounce is gaining traction on Friday morning, as market players focus on a fiscal stimulus bill and are hoping that greater visibility will start to emerge into the economic damage being done. For now, they are setting aside some worries about the coronavirus, but they are very likely to flare up again as more news hits about the spread of the virus.
In the early going, the S&P 500 is indicated to jump over 3%, which will take it back to where it was Tuesday. Although that is cold comfort for those that have been buying in the last couple of weeks, it feels like a victory to see green on the screens. The important thing at this point is to be very careful about believing that the worst is over and to consider some repositioning if you have taken on too much risk recently.
There are several reasons that market players are inclined to embrace the idea of a V-shaped move at this point. The first is that the suddenness and severity of the drop suggests a reflexive bounce. Overreactions in one direction produce overreactions in other direction, but there is a tendency to want to believe that the countertrend bounce is a signal that it is all clear.
In recent years, there have been many V-shaped bounces -- with the one in December 2018 offering a classic example. That bounce was primarily a product of financial engineering by Treasury Secretary Mnuchin and the Federal Reserve Chairman Powell, after a collapse that started with the unwinding of something called the Short Volatility Trade. The sharp drop was not caused by any major economic news or outside news, even. It was mostly internal to the market, which is why it was relatively easy to repair with monetary moves.
The current bear market is very different from that market in 2018. It is much more similar to 2008-2009, when there were economic shocks that created profound uncertainty and had a domino effect. It took a series of major policy efforts, such as TARP and QE, to finally help produce a turn.
The current situation presents even more uncertainty than what existed in 2008-2009, and that is why countertrend bounces like we are seeing now should be viewed with great skepticism. There still is no clarity about the ultimate impact of the coronavirus.
The market is bouncing this morning because the rush to produce trillions in economic relief are providing some sense of control in an uncertain environment. We always feel better when we are aggressive in trying to solve our problems, even if the problem is not resolved.
The game plan for the market at this point is going to depend on your timeframe and investing style. Longer-term investors will want to hold on and hope that the action today is the first step in a bottoming process. More-aggressive investors and traders will probably want to look to do some repositioning. If you have caught a good bounce, then take some partial profits and watch for opportunities to reload.
Too many folks will fear that this is going to turn into a V-shaped bounce back to recent highs and will chase strength at the wrong time. Even if this does turn out to be a straight-up rally in the indices -- which I doubt -- you will still have plenty of time to rebuild individual stock positions in the weeks and months ahead.
Treat this action like 'A Bounce' and not 'The Bottom'. Carefully examine your trust in a possible V-shaped move and your fear of missing out.