One Down, Three to Go

By: Steve Sosnick, Chief Strategist at Interactive Brokers

Today marks the end of the first quarter of 2022. If I told you at the beginning of the year that the following would transpire, would you have expected that most major world indices would show modest single-digit declines?

• The Federal Reserve would be raising rates and begin discussing balance sheet reduction
• Inflation would run between 5 and 8 percent, depending upon your preferred measure
• US bond yields would zoom higher, with 2-year yields nearly tripling and flirting with inversion
• Russia would invade Ukraine triggering global sanctions

All things considered, equity markets have done ok for themselves. Sure, we’ve seen more than our share of volatility – which was indeed something we anticipated – but thanks to a furious equity rally over the past fortnight, stocks aren’t far from where they started the year. 

That said, it is far too early to issue an “all-clear” for investors right now. We don’t know yet whether the recent movement was a medium- to long-term trading bottom, short, sharp, and ferocious bear market rally, or a bout of socially acceptable volatility.A case can be made for all of those scenarios, but my view falls somewhere between the latter two.  As we wrote yesterday, “My inclination is to infer that the bounce was more the result of technical and timing factors rather than a paradigm shift”, and went on to offer the following hypothesis:

“I believe that institutions were raising cash from January through mid-March, as central bank headwinds and geopolitical tensions raised angst among portfolio managers. Throughout that period, individual investors who have become conditioned

to and generally rewarded by buying dips continued to keep the faith. Just before the FOMC meeting two weeks ago, many institutional investors recognized that equities had become somewhat oversold. As the market bounced, those institutions realized that they were holding too much cash in a bouncing market ahead of a quarter-end reporting period. Asset allocators continued to sell fixed income, but the proceeds have been more aggressively deployed into equities in recent weeks.”

In short, institutional investors found themselves holding too much cash ahead of a quarterly reporting period. They were comfortable holding excess cash when markets were plunging nervously but rushed to deploy it before they needed to explain to their clients why they were so cautious amidst a newly sanguine market. If this is indeed the case, we would expect to see an easing of buying pressure once they accomplished their goal of being able to report less conservative portfolios in their first-quarter reports.

So far that is proving to be the case. Remember that stocks settle T+2, meaning that shares are actually owned by buyers two business days after they are purchased in the market. That means that institutions who wanted to show stock positions on their quarterly reports would have needed to purchase those shares no later than Tuesday the 29^th. The sharp end-of-day runups that we saw on Monday and Tuesday had the hallmarks of aggressive institutional buying, while the modest declines that we saw yesterday and this morning lack that aggression:

S&P 500 Index (SPX), 4 Day Chart, 5 Minute Bars

Source: Interactive Brokers

Yesterday’s activity seemed to indicate that traders were waiting for institutional follow-through that never arrived. We may be seeing the same sort of thing today, though we can’t rule out a bout of late window dressing among popular names.

Thus, I am sticking with the hypothesis that I laid out yesterday. It hasn’t been proven correct yet – that will take time – but neither has it been proven wrong yet.