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S&P 500: Why This “Irrational” Market Is Perfectly Rational

Published 02/16/2018, 12:00 AM
Updated 07/09/2023, 06:31 AM
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S&P 500 Index Daily Chart

The S&P 500 extended last Friday’s rebound and reclaimed the 50dma. This marked the fifth consecutive day of gains and firmly puts last week’s selloff in the rearview mirror.

A week ago the market collapsed on fear of rising inflation and interest rates. This week we got further data showing inflation was heating up, yet this time the market rallied. What gives?

As contradictory as those two responses seem, there is actually solid logic behind the market’s “irrational” behavior. Last week nervous owners abandoned the market and kicked off a dramatic correction. But here’s the thing about sellers, they only get to sell the market once. After that they no longer have a say in what comes next. Nervous owners sold inflation headlines and dumped their stocks at steep discounts. Confident dip-buyers snapped up those discounts. Out with the nervous and in with the confident.

These confident dip-buyers bought last week during the height of the inflation scare, so another round of inflation headlines this week were unlikely to scare them. Turnover in ownership is how headlines get priced in and why they stop mattering. Once all the people who fear inflation are out of the market, there is no one left to sell the next round of inflation headlines. No sellers means no selloff.

When people claim the market is acting irrationally, what they are really saying is they don’t understand what is going on. There is always sound logic behind every move. If we don’t understand it, all that means is we need to dig deeper.

Thursday's gains pushed the S&P 500 back above the 50dma and recovered half of the selloff. In a normal market, I would be worried about the sustainability of this rebound. Typically the market remains choppy after a dramatic selloff. But this market continues to surprise us with its ability to defy conventional wisdom. January’s nearly straight up rise lasted longer that it should have. Last week’s selloff went further than it should have. And now there is a good chance the current rebound will also surge far higher than expected.

Even though we keep going up, that doesn’t mean this is a good place to buy. The risks have changed dramatically from last Friday’s lows. The best buys occur when the crowd is terrified things will get worse. Last Friday most definitely qualified as a great buying opportunity and that is exactly what I told readers of this blog the night before. But this week we find ourselves in the middle of a market filled with relief. While we are still well under January’s lows, long gone is last week’s doom and gloom. Even though momentum can keep us rising over the next few days, that doesn’t make this a safe or smart place to be buying. If someone missed the rebound, chalk it up as a lesson learned. Remember, it is better to miss the bus than get hit by the bus.

Those with swing-trading profits should start thinking about locking them in. Those with cash should sit on their hands and wait for a better entry point. And long-term investors should stick with their favorite stocks.

Bitcoin finally traded above $10k, making this a 66% bounce off of the $6k lows. Even though we are in the middle of a massive selloff, there are still very profitable trades along the way. Two-weeks ago I warned readers prices would to tumble under $8k, but also said this was a dip-buying opportunity and prices would rebound back to $10k. And that is exactly what happened. There is no magic to this. The same things keep happening over and over again and it is simply a matter of paying attention.

And just like the equity market, the easy gains are already behind us and buying here is a much riskier proposition. We could coast up to $12k over the next few days, but the risk of a sharp selloff is never far away. Without a doubt this is little more than a bounce on our way lower. We the real bottom is still months away and under $4k. But until then, look for more profitable swing-trades. And most importantly don’t forget it is far easier to sell Bitcoin on the way up. Hold too long and these nice profits will evaporate.

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