After the Stock Market Was Roiled by Volatility, What Could Happen Next?

The recent turbulence in the U.S. stock market has brought back memories of volatility for investors, following an unusually extended period of market calm. This resurgence of volatility could potentially signal a significant shift in market sentiment, according to Jason Goepfert, founder and senior research analyst at SentimenTrader.

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The S&P 500, a large-cap benchmark index, experienced significant intraday movements of at least 1% for eight consecutive sessions, culminating on Thursday. This volatility was driven by the unwinding of a Japanese yen carry trade and increasing concerns about the strength of the U.S. economy, which sent shockwaves through global financial markets over the past two weeks.

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In a note released on Monday, Goepfert highlighted that over the past 10 trading sessions, which concluded on Friday, the S&P 500 saw an average maximum intraday range of at least 2%. This marks one of the largest 10-day average intraday ranges in the past decade. The chart accompanying Goepfert’s analysis traces the S&P 500’s maximum intraday ranges dating back to 1957. According to him, the 2% threshold has generally contained most "normal" 10-day average intraday movements. However, there have been instances where the 10-day range exceeded 3%, with only three occurrences of what he described as "all-out blow-out" moves.

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The recent bout of volatility over the past two weeks also brought an end to what Goepfert referred to as a "historically long streak" without a 2% 10-day average intraday movement in the S&P 500. This development, according to Goepfert, raises the possibility of a shift in market sentiment. He noted that it’s the first time in 430 sessions that investors have encountered such significant intraday fluctuations.

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Typically, a sharp increase in intraday ranges would lead to a temporary shakeout in the stock market, followed by a resumption of the uptrend after a few weeks of volatile trading. However, Goepfert cautioned that recent history doesn’t strongly support this pattern, particularly over the past 25 years. He pointed out that while spikes in intraday volatility provided good entry points for long-term investors in 2011 and 2015, the same couldn’t be said for other instances. In those cases, the signals often resulted in more risk than reward over the following year.

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Goepfert advised closely monitoring how investors react to the recent upheaval in the stock market. He suggested that if the S&P 500 continues to hit lower lows, investors should prepare for a potential shift towards defensive stocks. This would indicate a more cautious market environment, where investors prioritize stability and income over growth.

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On Monday afternoon, U.S. stocks were mostly lower, as the three major indexes struggled to build on the rebound seen on Friday. According to FactSet data, the S&P 500 was down by 0.1%, the Dow Jones Industrial Average had lost 0.5%, and the Nasdaq Composite was slightly up by 0.2%.

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This return of volatility has been a wake-up call for investors who had grown accustomed to a relatively tranquil market environment. The S&P 500's recent movements are particularly noteworthy because they contrast sharply with the low-volatility conditions that prevailed for an extended period. Investors are now grappling with the implications of this shift and what it might mean for the future direction of the market.

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The unwinding of the Japanese yen carry trade, a strategy where investors borrow yen at low-interest rates to invest in higher-yielding assets, has been a key factor contributing to the recent market turbulence. As this trade unwinds, it has sparked concerns about broader financial instability and the potential for a weakening U.S. economy.

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Additionally, fears of a slowing economy have further exacerbated market volatility. Investors are increasingly worried that the U.S. economy may not be as resilient as previously thought, especially in light of mixed economic data and ongoing uncertainties. These concerns have led to heightened market sensitivity, with investors reacting strongly to any news that could signal a change in economic conditions.

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The significant increase in intraday volatility has left investors questioning whether this is a temporary blip or the beginning of a more prolonged period of market instability. Goepfert’s analysis suggests that while past instances of heightened volatility have sometimes provided buying opportunities, the current environment may be different. The market's response to the recent volatility will be crucial in determining whether this is just a temporary disruption or the start of a more significant shift in market sentiment.

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In conclusion, the recent volatility in the U.S. stock market has reminded investors of the risks associated with investing in equities. The sharp movements in the S&P 500, driven by concerns over the unwinding of the yen carry trade and fears of a weakening U.S. economy, have raised the possibility of a shift in market sentiment. Investors will need to stay vigilant and be prepared for potential changes in market dynamics, particularly if the current volatility persists.

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