Reading the volatility tea leaves

Recently, investors might feel that every rally in the S&P 500® Index will eventually end with aggressive selling, unleashing volatility and crushing investor sentiment. In times of peaking pessimism and extreme bearishness, investors often try to parse how the financial markets are reflecting an array of risks. After all, understanding risk is a crucial part of the investment process. However, how might the market reflect its trepidations when trying to digest those risks?

The answer lies in volatility. Market participants have noted that strong selling occurs when the market is selling off but the follow-through when the market rallies are not seeing the same level of conviction. With downside risks looming from a hawkish Federal Reserve and a potential “earnings apocalypse” in investors’ minds, investors should understand that such volatility is not unusual for the equity markets.

With each bounce in the market, investors can easily mistake volatility for a change in sentiment. This year’s equity market volatility illustrates how erratic the market can be and why market timing can be a perilous endeavor. The past 201 trading days have been anything but tranquil, with only 43% of the trading days ending positive. As the bull-bear debate rages, investors should consider that over half of this year’s trading days have seen daily moves greater than 1% in either direction. Even more interesting is how the S&P 500 Index has seen 19 days where the index has gained more than 2%. For context, the S&P 500 saw gains of more than 2% on two days in 2021, 19 days in 2020, and two days in 2019.

In the past month, there have been five sessions where the S&P 500 gained 2% or more, indicating that institutions are dipping their toes in the water. This behavior is like what was seen near the bottom in 2002, 2009, and 2020. This year will likely prove historic for market statisticians as volatility and uncertainty will likely continue to roil the financial markets.