When the stock market indexes swing up or down 1% or more I try to share my observations of the directional trend and changes in volatility. Continuing from my observation yesterday in Observations of the stock market decline and volatility expansion when I shared:
The good news is, we’ve now experienced some volatility expansion, stocks have now pivoted down to the lower end of their cycles, so maybe volatility will contract and stock prices resume their uptrend.
Well, today we saw.
The U. S. stock market gains were broad across all sectors. Communication Services, Consumer Discretionary, Healthcare, and Technology were the relative momentum leaders.
Continuing with the % of S&P 500 stocks above their 50 day moving average as breadth indicator was another indication of broad upward momentum. 86% more stocks are trading above their shorter-term trend, an expansion from a low level. For those of us who like to enter trends early in their stage, this is a positive sign of improvement for the stock market.
We observe the same in the percent of stocks trending back above their longer-term trends. There was a 16% expansion in the stocks in the S&P 500 index trending above their 200 day moving average. The longer-term trend indicators are slower to respond, but this is more evidence of positive directional movement.
This is happening at a time when many investor sentiment indicators suggest fear has been driving stocks recently. A simple example is the Fear & Greed Index, which reached “Extreme Fear” a week ago.
As a portfolio manager for the past two decades, I have observed investor sentiment oscillate between fear and greed, but as a contrarian pendulum. Most investors feel the wrong feeling at the wrong time.
- After prices rise, investors get more optimistic as they extrapolate the recent gains into the future expecting the gains to continue.
- After prices fall, investors fear losing more money as they extrapolate the recent losses into the future expecting them to get worse.
What happens, though, is market trends move in multiple time frames of cycles up and down. Prices can overreact to the upside and downside and the majority of investors seem to get it wrong.
The level and direction of implied volatility is an indication of investor sentiment. I’ve shared my observations of the volatility expansion and noted some volatility contraction yesterday. So far, the volatility expansion has reversed to contraction, so the expected volatility as implied by options prices now suggests the market expects lower volatility in the weeks ahead.
But, just as I pointed out on September 25th in VIX level shows market’s expectation of future volatility implied volatility can get it wrong. I pointed out then the implied volatility was very low signaling to me the market may have been wrong to expect such low future volatility, so it can reverse back up again.
In summary, today was a strong upward momentum day for the stock market and most stocks participated in the uptrend. After sharp declines like we’ve seen this month, the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low. After the test, we then find out if it breaks down or breaks out.
One day doesn’t make a trend, but for those who are in risk taker mode with stocks, so far, so good.
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