By Joseph Adinolfi
U.S. stocks kicked off the fourth quarter with sharp gains as the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -1.03% appears headed for its biggest two-day rally in more than 2½ years.
But as tempting as it might be to call a bottom in stocks, Nicholas Colas, co-founder of DataTrek Research, said Tuesday that investors should brace for more carnage in the near term as several reliable historical signs of a durable bottom are still missing from markets.
Valuations are still too high, Colas said, and although 2022 has seen immense two-way volatility in stocks, sharp moves higher historically tend to signal that more volatility might be in store for stocks.
“Happy as we are that U.S. equities had a nice bounce today, this move is best considered as just another day in a rough year,” Colas said.
While they have been extremely common since the start of 2022, historically speaking, single-session advances of 2% or more are a relative rarity for markets. Since 2013, years that contained fewer single-day advances of 2% or more tended to result in stronger performance over the course of the year, Colas said.
The one exception to this was 2020, when the S&P 500 registered 19 daily gains of 2% or more. However, Colas argued that most of these outsize moves occurred during the first half of the year, when markets were still reeling from the onset of the COVID-19 pandemic.
During the second half of the year, the S&P 500 saw exaggerated moves in only two sessions, as Colas shows in the chart below, using data from DataTrek.
|Year||S&P 500 total return||Days with 2%+ moves|
|2020||+18%||19 (but only 2 during H2)|
|2022||-22.8% (price move through Monday without dividends reinvested)||14 days|
“Simply put, strong 1-day S&P rallies (+2%) are NOT the sign of a healthy market,” Colas wrote.
How do we know the bottom is in?
In the past, when long-term bottoms have arrived, stocks have typically greeted them with a large intraday move of at least 3.5%. This held true for the cycle lows that arrived in October 2002, March 2009 and March 2020.
Based on this benchmark, Monday’s bounce wasn’t large enough to signal a meaningful turning point.
|Day after cycle low||S&P 500 performance|
|Oct. 10, 2002||+3.5%|
|March 10, 2009||+6.4%|
Valuations are still historically rich
Colas also argued that stocks are still relatively richly valued based on a popular measure of cyclically adjusted equity valuations.