The budding rebound in US stocks is probably more notable for what it lacks than what it represents in terms of animal spirits.
While the Standard & Poor’s 500 Index jumped 1.6% in the past five days to cap the biggest two-week surge in a year, a large portion of investors have watched the rally from the sidelines. The gains came amid the weakest volume in 2016, a sign that there is a lack of conviction in the advance following a 10% rout that erased more than $2.5tn from US equity values.
“The market is still very sceptical,” Ernie Cecilia, chief investment officer at Bryn Mawr Trust Co, which oversees $8.5bn in Bryn Mawr, Pennsylvania, said by phone. “. There’s a hesitancy for large, long positions to be made. We’ve remained very defensive and very selective.”
The S&P 500 jumped 4.5% in the past two weeks to 1,948.05, erasing its decline for February as it seeks to halt a two-month losing streak.
Equities shrugged off renewed turmoil in China - a frequent catalyst for selling this year - amid speculation that central banks stand prepared to add to stimulus, while crude’s rebound from a 12-year low lifted the beaten-down energy industry. The benchmark index plowed through its average price over the past 50 days for the first time in 2016, and measures of anxiety showed fear’s loosening grip.
Yet caution lingers. Three of the four lightest days of volume in 2016 occurred in the week, continuing a trend of weak participation during a 6.5% rally that started February 11. Daily trading has averaged 8.1bn shares, down 14% from average volumes during the six-week rout that started the year. Only 7.6bn shares changed hands each day in the last week, the least in 2016.
At the same time, a Goldman Sachs Group index of the most-shorted stocks surged twice as much as the S&P 500, a signal that wrong-footed bears added to the buying. The basket of the 50 companies with the highest short interest in the Russell 3000 Index surged 10% in the past two weeks, more than double the benchmark’s gain. Bearish bets on US stocks surged to the highest since 2008, as the ratio of short interest to float rose to 4.4%, according to data compiled by Bloomberg.
A “damaged” market needs “a lot of filling in” to combat persistent concerns about the threat of a US recession, said Quincy M Krosby, a market strategist at Prudential Financial, which oversees about $1.2tn. “If you’re a bear right now, you’re waiting and you’re setting the trap for selling.
Many of the most sustainable rallies do start with short-covering, there’s nothing wrong with that, but you need to see more than that, you need to see more money going into the market with conviction.”
Positive economic reports will help, Krosby says. Data in the week showed gross domestic product expanded at a faster pace in the fourth quarter than projected, manufacturing weakness may be easing and inflation rising the most since October 2014.
“We’re not getting fantastic data, but we are getting data that confirm so far that the US economy has been doing OK,” said Bo Christensen, chief analyst at Danske Invest in Copenhagen, which oversees $116bn.
Measures of investor anxiety eased, as the Chicago Board Options Exchange Volatility Index averaged 20 during the week, more than a 20% drop from the week ended February 12.
Equity gains were broad-based, as nine of the industry’s 10 main groups advanced. Raw-materials producers and industrials stocks rose at least 2%, to levels last seen in the year’s first week.
As scepticism lingers about the sustainability of the recent rally amid concern that the economy could weaken into recession, investors are looking for fresh data that growth hasn’t deteriorated, with next week’s labor report set to deliver the next major clue.
“One of the basic issues of the market in terms of commitment on the part of managers and even traders, is that tug-of-war between those who say the recession is lurking versus those who believe we’re pulling out,” Krosby said.
The lack of participation in the latest surge has Christensen waiting before signalling the all-clear. “The low volume we’ve seen is extremely important because we’re looking forward to next week for more conviction on where we go from here,” he said.