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Market keeps punishing stock bulls

Eight interest rate hikes since 2015 may not have ended the bull market, but are showing up in day-to-day swings.

There is more volatility ahead, but where the proper multiple lies is anyone's guess, says Morgan Stanley strategist Mike Wilson. Figuring this out is taking a toll on investors' nerves.

PITY the tech investors who poured US$2 billion into an exchange-traded fund just yesterday. Pity the bulls who thought they'd ride their way to riches buying the S&P 500 on Labour Day.

Pity just about anyone who isn't long volatility, as the US stock market twists in its fifth one-per-cent swing in seven days. The VIX is above 20, the S&P 500 is down five per cent in three weeks, and 10-year Treasury yields aren't far below the highest level since 2011.

Things that used to be helping are hurting. Interest rates are up and earnings growth - the fuel for the longest bull market on record - is poised to shrink. That's a tough combination: over the last 70 years, rising rates and diminishing profit growth are the only macro backdrop that has generated a negative quarterly return in the S&P 500, notes Strategas Research Partners.

John Carey, a managing director and portfolio manager at Amundi Pioneer Asset Management, said: "Just pick your problem from one day to the next, and it's enough to send shivers through different parts of the investment community. Even though earnings are coming in fairly strong, we're seeing this phenomenon where stocks get punished."

Eight interest rate hikes since 2015 may not have ended the bull market but are starting to show up in day-to-day swings. The S&P 500, which soared 2.2 per cent on Tuesday, fell 1.4 per cent today, while the Cboe Volatility Index climbed as high as 21.5.

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At the crux of the volatility is a desperate attempt by investors to establish a valuation model for stocks that accounts for shifting interest-rate and earnings expectations. At 16 times forecast earnings, the S&P 500 is trading at the lowest forward multiple since early 2016. While that served as a support in the February-March rout, strategists such as Morgan Stanley's Mike Wilson argued for a lower P/E ratio now.

Sixteen times next year's earnings "is now more likely a ceiling, not a floor, for the S&P," Mr Wilson wrote in the note to clients earlier this week. "There is more volatility ahead." Where the proper multiple lies is anyone's guess. But going back to the start of the bull market, the average stands at 15. Should the market return to the mean, it would imply a 6 per cent decline, all else equal. Figuring all that out takes time and time is starting to taking a toll on investors' nerves as bad days pile up. To wit: while most of 2018's sessions have been up, ones for the S&P 500, when the market falls, it falls a lot. Single-day drops have been 14 per cent bigger than gains this year, on average, the widest gap since 2011, data compiled by Bloomberg show.

Stocks have slumped almost 5 per cent since the end of August, and while a lot can happen in two months, that's not a good start for a trade that has worked literally every year since the bull market began. Buying and holding the S&P 500 between Labour Day and year-end has generated gains averaging 7.2 per cent annually. They ranged between 1.4 per cent in 2012 and 13.9 per cent in 2010.

Earnings, billed as the market's savoir in the weeks before reporting season, have become an after-thought. Companies are, as usual, far surpassing analyst estimates - after guiding the same estimates down at the fastest pace since data beginning in 2010. And measuring the impact of corporate announcements gets a little moot in a market that has risen or fallen by 1 per cent in five of the last seven sessions.

Investors are having trouble discerning signals. Netflix Inc reported blowout quarterly growth on Monday and rallied in after hours, buoying hopes that the broader FANG cohort would follow suit and prompting investors to put US$1.9 billion into the Invesco QQQ ETF on Wednesday. The security is down 2.4 per cent today.

Gina Martin Adams, chief equity strategist at Bloomberg Intelligence, said: "Our regime-detection model suggests positive returns with bouts of volatility remain likely in this late stage of the cycle, consistent with a market that behaves more like a sheep than a bull. Tightening monetary policy and trade-policy uncertainty may continue to weigh on risk tolerance." BLOOMBERG

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