When I was growing up, I was fortunate enough to live in a neighborhood that had a community pool. It was a fun place to hang out with friends on hot summer days. When the inevitable summer storm appeared on the horizon, the lifeguards would clear the pool to ensure that no swimmer would be electrocuted by a lightning strike. If the storm passed quickly and sunny skies reappeared, the lifeguards would give an “all clear” and swimmers could return to the water. If only the markets were quite that simple.

The recent downdraft and yesterday’s rebound in the S&P 500 (SPX) and especially the Nasdaq 100 (NDX) indices had some of the hallmarks of those days. The problem for investors is that there is no one to reliably tell them when it is time to exit or re-enter the markets. I don’t know of any studies that compare the expected capacity of market pundits versus meteorologists, but I highly suspect that the latter offer more accurate outlooks. Worse, I’ll assert that having someone act on an incorrect market call has more consequences than having someone forget an umbrella (though many fewer than being hit by lightning).

It has been quite clear that over the past two days, all sorts of traders and investors jumped back into the pool of risky investments. Besides NDX bouncing by about 4%, led by a near 20% rise in Tesla (TSLA) that added about $100 billion to its market capitalization, we saw money flowing into bitcoin, meme stocks, and a wide range of speculative products. Of course, if it were a truly risk-off day we would have seen bond yields rise, but that didn’t occur. Because they avoid credit risk, Treasury bonds are typically bid higher as havens on risk-off days and shunned on risk-on days. But with stock prices keying off bond yields in recent weeks, a rally in bond prices (aka falling yields) can be a risk-on signal for stock investors. 

It is that change in the historical risk-on / risk-off relationship that has me concerned that the current rally is little more than a bounce, not a true all clear. Last week, I wrote: “At present, I would take the message of the VIX index and remain poised for volatility over the short-term.”I still stand by this message for two reasons. First, upward moves count as volatility too. Though we typically see the CBOE Volatility Index (VIX) rise during up downward moves (and vice versa), that is more a behavioral phenomenon rather than a mathematical one. I explain that at length here.

Secondly, as noted above, we are being driven by a historically anomalous set of circumstances. Bond and stock investors typically have different motivations, though they have become uneasy bedfellows because of a shared fear of inflation and a sustained reliance upon central bank liquidity. Their marriage of convenience can end suddenly and with unanticipated consequences. Unanticipated consequences bring volatility.

Here in the northeastern US, we are seeing welcome signs of spring. Even without meteorological training, I can confidently say that generally warmer weather will be returning over the coming weeks, if not day-to-day. By the same token, I can reasonably expect an improving mood among the general public as vaccines are administered and stimulus checks are deposited. Yet there are unsettled undercurrents in investment markets, and those make it difficult to give a full “all clear” for investors.