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Signs of seller exhaustion make stocks prepare for a big bounce


(Bloomberg) — A pattern has existed in stocks for the past year. A downhill pullback, sellers exit their system, and the market is ready for a typically strong jump.

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Friday’s surge, which left the S&P 500 without a fifth straight week of declines, bearing all the hallmarks of that habit, comes amid a wealth of evidence that investors’ risk appetites have been undermined. cut to the bone. Data from JPMorgan Chase & Co.

Those trends would explain two things. First, last month’s monstrous returns, the aftermath of a massive sell-off, pushed the S&P 500 to its worst December drop in four years. And two, Friday’s lively reaction to the news that payroll additions were higher than expected in the US economy, as seven out of eight previous jobs reports resulted in losses.

“If you look at a bunch of sentiment indicators, they generally show that investors are a lot more cautious than they were a year ago,” said Dan Suzuki, vice president of investments at Richard Bernstein Advisors. “That is most likely laying the groundwork for another short-term bull run, as we seem to get every few months.”

Stocks ended their longest weekly losing streak since May last year as the S&P 500 rallied during the shortened holiday period. The benchmark, which ended 2022 with its worst annual slide since the financial crisis, was up 1.5% in four days, while the Dow Jones Industrial Average rose for a second week in three. week.

Last year’s stock boom cycles are often correlated with changes in retail and institutional positioning. Profits occur after investors cut their bullish bets and fall after buying. The relentless ups and downs make gathering economic signals from the market—never an exact science to begin with—especially futile, with trends in the market only temporary. Friday’s rally in the S&P 500 also came after a sharp drop in risk-on sentiment.

Another key contour of last year’s investment landscape echoed this week: value outperforms growth, with an index that tracks cheaper stocks beating that of fast-growing stocks. 2 percentage points. One takeaway from that might be a slightly less dreary economic message than is normally delivered from the markets at large. Obviously, growth companies are part of the economy, but the battering of those stocks was mainly due to shrinking valuations. Value stocks are less bloated to correct and their relatively light losses as a result can be taken as a clearer and happier signal about future activity.

Sessions when the monthly payroll data were released recently weren’t good for the stock. Among last year’s employment days, all but three of the S&P 500 indexes fell as the economy largely added more jobs than expected, clearing the way for the Federal Reserve to tighten monetary policy as This agency fights inflation. The ominous pattern, coupled with the specter of a severe recession, has forced investors of all sectors to cower after a brutal year that saw stocks and Treasuries take a beating. worst annual loss in more than a century.

Data compiled by JPMorgan’s lead brokerage shows that hedge funds betting on bullish and bearish stocks increased their short positions in December, with their average leverage falling to lows. The most since 2017. A similar trend is evident at Morgan Stanley, where gross leverage among the company’s hedge fund clients is near a five-year low.

While nonfarm payrolls once again beat forecasts in December, traders took comfort in the cooling of wage gains. The S&P 500 rose 2.3% on its best response to the jobs report in more than two years.

“Lower weekly hours will result in a lower representation of real labor income, which means weaker spending going forward,” said Dennis DeBusschere, founder of 22V Research. “This won’t change the Fed’s outlook much in the short-term but does reduce the likelihood that they need to crush things.”

The first signs of a recovery enough to lure some bulls back in after last year’s $13 trillion write-off drove stubborn retail bulls mass retreat. Individual traders, who bought into the drop in early 2022 only to get burned again and again by the year-long slump, sold more than $3 billion in shares in the past year. week to Tuesday, the third-biggest sell-off in JPMorgan’s data history.

According to Peng Cheng, corporate strategist, who made estimates from publicly available data on exchanges, while the year-end tax sell-off played a role in the exodus, cash outflows The massive outflow also reflects the growing bearish sentiment of the crowd.

All defensive positions are likely to set the stage for a market rally, as has happened several times in 2022, as protracted sell-offs gave way to quick buybacks before action. selling continues. In a year in which the S&P 500 lost about a fifth of its value, the index has three times recovered more than 10% from the bottom.

From peak inflation to speculation about the Fed’s pivot, investors have relied on a variety of catalysts to buy stocks. Each rally eventually faded. Stocks have made small gains since June, with the S&P 500 largely stuck in the 700-point range.

However, those bounces were short-lived, with evidence that they bothered Fed officials. Minutes of their last policy meeting released this week showed some members warning against “unwarranted easing of financial conditions” that could undermine efforts to contain slow down the economy and control inflation.

With banks starting earnings season next week, investors may be content to wait for clearer health news, according to Christophe Barraud, chief economist and strategist at Market Securities LLP. strength of American business.

“Last year, the mood changed a lot because every time people bought, the market sold more,” he said. “People would probably prefer to buy now after making sure that there is a strong force behind the stock.”

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