U.S. stocks could be ready to test lows

Market is ‘following script,’ analyst says

Why would someone who is generally positive on the equity market, and actually sees the S&P 500 rising more than 10 per cent by the end of 2018, be talking about a retest of the recent lows?

As Tony Dwyer, a New York- based analyst at Canaccord Genuity explained: When a retest occurs, “fear it is something more significant causes many to reduce risk, just at the very time history suggests increasing it.”

Keep in mind that Dwyer has a 3,100 target on the S&P 500, and believes tailwinds such as solid global growth, accelerating U.S. economic activity, an improvement in capital spending, and strong employment leading to a jump in household incomes, will serve to offset heightened volatility.

Nonetheless, the analyst is calling for a retest of the lows that coincided with “shock drop” that ended the week of Feb. 9. After looking at previous instances of historic spikes in the 10- week rate of change in volatility as measured by the VIX, he found that stocks rebounded (excluding 2008) an average of 5.62 per cent, before they retested the low 30 trading days later.

With stocks up nearly five per cent from that recent low as of Monday, Dwyer noted that “the market is following the script.” That means the comfort provided by the equity rebound should quickly fade, whether that’s because of the Federal Reserve, disappointing data, or a combination of the two.

“We believe the expected volatility, with limited progress over the coming months, is a result of economic data that is likely to scare the Fed and investors — but in a different way,” the analyst said. “The data is likely to show growth that is good enough to keep the Fed fearful of inflation, while investors are fearful of a second derivative slowdown from elevated expectations.”

Dwyer noted that while short volatility vehicles like ETFs may have contributed to the severity of the recent “shock drop,” excessive optimism and very low concern about the fundamentals preceded it.

“Expect the whooshes and ramps to continue,” he said.

Along with U.S. stocks, global equities continue to recover off the lows of earlier February, but the momentum behind the buying hasn’t been aggressive.

“Having come off the back of such a sharp sell- off it’s taken some time for investors to start putting money back into the market,” said Michael Hewson, chief market analyst at CMC Markets UK.

He noted that while U.S. yields are falling, with the 10- year hitting a one- week low, investors appear happy to slowly put money back into stocks.

This trend has accelerated in the past few days, as major U.S. indexes are quickly approaching their record highs once again.