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Cracking the Code: 5 Reasons a Choppy Market Looms

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Trendless Markets are an Investor’s Worst Nightmare

Over my two-decade active investing career, I have learned valuable lessons by studying my trading history extensively. In looking back at my investments and the investing environment when I made the investment, I learned unsurprisingly that my best results came during bull markets (defined by the S&P 500 Index trending above its 50-day moving average). Because about 75% of a stock’s performance is correlated to the general market’s direction, the results of my post-analysis make sense. However, the most surprising takeaway from my historical study of my trading history was that I did not lose the most money in bear markets. Instead, the biggest drawdowns in my equity curve occurred during trendless, choppy markets (as defined by the S&P 500 Index stuck between the intermediate-term 50-day moving average and the long-term 200-day moving average.)

Don’t only take my word for it; listen to two investing juggernauts from completely entirely different eras:

Jesse Livermore, who amassed his massive fortune during the Great Depression crash of 1929, warned of trendless markets by saying, “There is a time to go long, a time to go short, and a time to go fishing.”

Similarly, Ed Seykota, a trend following pioneer with a money management track record of ~60% annually net of fees over 30 years, felt so strongly about trendless markets that he composed his own tune appropriately named “The Whipsaw Song.”

While amateur investors seek to extract money from the market regardless of conditions, elite investors understand the importance of sitting on their hands and waiting patiently for a trend to develop. For equity investors, five items suggest that a trendless market may be in the works over the next few months, including:

Seasonality: Sell in May and Go Away?

Historical seasonality trends dating back to 1949 indicate that the S&P 500 Index tends to fluctuate in election years until June before rallying into year end.

Zacks Investment Research
Image Source: Almanac Trader

Geopolitical Uncertainty

As the Russia/Ukraine war drags on, tensions between Iran and Israel have escalated recently. Though the tit-for-tat between the adversaries appears to be over in the short-term, the cloud of war continues to hang over equity markets and could lead to a “headline-driven” market.

Sentiment Bearish, But Room Lower

Sentiment indicators suggest that investors have one foot out the door. Despite the relatively tame pullback in the S&P 500 Index, sentiment has shifted from “Extreme Greed” to “Fear” in just a handful of days. While the poor sentiment is bullish from a contrarian perspective, there is room to go lower in the next few months.

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Image Source: CNN

Muddled Fed Policy Picture

Wall Street’s interest rate expectations have fluctuated dramatically as several Fed officials have opposing views, inflation remains stubborn, and commercial real estate concerns loom. For example, the Chicago Mercantile Exchange ((CME - Free Report) ) “FedWatch” tool gives the odds of a rate cut and no change in rates for July at around a coin flip. Because Fed liquidity is a significant market driver, the uncertainty around monetary policy may lead to uncertainty in equities.

Digestion Pullbacks are Normal

Nvidia ((NVDA - Free Report) ), Super Micro Computer ((SMCI - Free Report) ), and Arm Holdings ((ARM - Free Report) ) were victims of carnage in the tech sector last week. However, before the correction, each had gone on tremendous bull runs. In other words, some digestion is expected and warranted at this juncture. Meanwhile, Ryan Detrick of Carson Research points out that, “The S&P 500 has a max pullback of 5.5% in 2024 so far. Since 1980, only 4 years saw a smaller pullback. The average year since 1980 saw a 14.2% max pullback.” Investors should reach the conclusion that even though the recent pullback may have felt painful, it would be normal for stocks to retreat further and still maintain their bull trend.

Bottom Line

Savvy investors understand that choppy, trendless markets are the most dangerous. Five indicators suggest a choppy market ahead.

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