I know what you’re thinking: you’d have to be crazy to believe we’ve seen the last of potentially market-crunching pronouncements from the Trump administration. The share markets aren’t so much gripped by complacency as blind hope.
And yet, from its recent bottom on 8 April, the S&P 500 rose by 19.7% over the following 28 trading days and is currently only 5% from its all-time high.
The bounce back by the US share markets has been one of the fastest in history, which has added to the sceptics’ concerns that it’s been the so-called ‘dumb money’, that is, retail investors, that have driven the rally by blindly buying the dip, while the institutional and hedge fund managers have been more cautious.
As always in times of elevated market volatility, the question on every investor’s mind is whether we’ve seen the worst. And, as always happens in times of elevated market volatility, baked in human biases influence our thinking and affect our objectivity.
There’s a bunch of indicators that suggest we may have seen the worst for the US markets. Many of them are based on what’s called ‘breadth’ analysis, which is looking at the proportion of stocks in an index that have gone up versus down. The higher the proportion going up, the more bullish is the signal.
There’s one that is particularly interesting, which has the formidable title of the Zweig Breadth Thrust. Marty Zweig was a high-profile financial analyst and manager from the 1970s through to the 1990s.
This indicator has been triggered 20 times since WW2, the latest being on 25 April this year. Across the previous 19 times the average increase in the S&P 500 six months after being triggered has been 14.8% (versus 4.5% on an average year), and 12 months after it’s 23.4% (versus 9.2%), and it’s had a 100% strike rate, in other words, 19 out of 19 (versus 72%) – see chart 1.
The difference between the sample years versus the average years is significant enough to argue it’s signal rather than noise.
A second notable indicator triggered on 22 April, when 98.2% of the S&P 500 constituents closed up on the day. That puts it in the top 0.02% of days.
If you break down the advance/decline ratios by deciles, that is, the top 10% of days through to the bottom 10%, and look at how much the index has risen over the following year, there’s no discernible pattern, it sits between 8-12%, so it’s just noise.
But if you look specifically at the 20 days since 1990 that sit in that top 0.02%, the average 12-month return was 21.8%. Again, that difference is so significant that you can argue it’s signal.
Now, if there were only two examples of these indicators, you’d be justified in treating them as interesting, but not necessarily convincing. But there are more, a bunch of which are summarised in chart 3 below.
Why would you pay attention to these kinds of indicators? Because the cause of market volatility is different every time, tariffs, pandemics, debt crises, etc, but the psychology behind how crowds react never changes. These indicators reflect that crowd psychology.
You can add fundamental reasons to the current situation as well. It appears President Trump is paying more attention to the signals coming from financial markets, including bond yields.
Part of the reason for that may be that Trump is listening more to the Treasury Secretary, Scott Bessent, who was a very successful hedge fund manager for 40 years before joining the administration, and who is now the go-to guy for communicating financial policies.
At the same time, Peter Navarro, who was the architect of the tariff program and who refused to countenance opposing views, has been sidelined and has all but disappeared from view.
There is still a lot of anxious debate in the media that the market appears to be ignoring the likelihood of earnings downgrades coming from the still higher tariffs that are in place; that policy uncertainty is so high that companies will opt to do nothing and investment will dry up; that consumer spending will evaporate in the face of tariffs causing higher prices; that US stocks are already trading on relatively high valuations.
You can always find bearish arguments, but if the media’s talking about them, and analysts are writing about them, then you will usually find the market has already factored them in.
Think back to the COVID selloff, the market fell 34% in only 24 trading days, and was back within 4% only 53 days later, by which time we still weren’t even certain how the virus spread, let alone having any ideas about vaccines and restarting economies.
The indicators we’ve looked at aren’t magic, and we haven’t given thought to the range of past outcomes. It’s also pretty much certain there will be more volatility to come, because markets don’t go up in straight lines. However, a smart investor can take comfort that there are good reasons to stick to a long-term plan.