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Because the market falls and investor concern will increase, year-end comeback odds are assessed

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A trader makes a phone call in front of the New York Stock Exchange in the Manhattan neighborhood of New York City, New York on October 2, 2020.

Carlo Allegri | Reuters

Scared enough already?

Yes, it is the time in a stock market retreat when the question turns of whether enough concern has arisen to dispel complacency.

Year-end rallies into winter tend to happen, but they are usually born in a terrible fall when investors start to doubt a fourth-quarter upturn.

Last week's 5.6% decline in the S&P 500, which pounded many of 2020's top performers and brought the index back from its high nearly two months ago to a 9% decline, did not result in an obvious terrible crescendo .

However, the three-week sell-off dented street confidence in a ramp in the fourth quarter, squeezing quick cash out of trending trades, and sparking more hedging ahead of the election. It's a start

It should be said that the typical levels of investor attitudes have not reached fearful extremes, or at least did not reach them by mid-week. In fact, multiple readings can best be characterized as moderating the heightened optimism from a few weeks ago. These include the weekly Investors Intelligence survey of investment advisors, which is still nearly 60% bulling as of last week, and the National Association of Active Investment Managers' weekly stock exposure index shown here.

Still, options traders have shown more nervousness, with buying puts being stronger to play the disadvantage. Company insiders have largely stopped selling their shares. And investors have stamped out fashionable speculative games like acquisition companies for special purposes. The CNN Fear & Greed Index has dropped to 30 on a scale from 1 to 100 and is well in the range of fear. The ETF that tracks SPACs – Defiance Next Gen SPAC (SPAK) – is down 14% since it was listed a month ago.

Unusual bonds move

Perhaps more noticeable than outright fear is a sense of confusion about unusual behavior in the asset markets.

Most noticeable was the sale of government bonds alongside the weakness of the stock market. Far from receiving an offer of security, the bonds pulled back and the yield on 10-year government bonds was 0.87%, a nearly five-month high.

As mentioned here last week, the explanations for the surge in returns have varied, from expectations of high household spending after the election, to catching up on other risk-weighted assets, to a general reluctance of investors to bet on assets before choosing.

The bespoke investment group after Wednesday's 3.5% dump in the S&P 500 noted that it had been just 24 days since 1962, when the S&P fell at least 3% and 10-year government bond yields rose . Does there have to be the usual panic rush on government bonds before stocks can bottom – or is this "sell all" impulse a sufficient panic in itself? "

The current breakdown of the expected reversal of stocks and bonds that is embedded in many investment models has likely thrown some traders off balance. The RPAR Risk Parity ETF (RPAR), which emulates popular hedge fund strategies that combine stocks and bonds bought in search of smooth returns with leverage, has been redesigned.

However, credit markets have remained relatively stable to the shocks in the stock markets, which arguably would not be the case if the market were stressed because of the Covid shutdowns that would stifle economic recovery.

And Strategas Group's Chris Verrone cites the relative strength of copper versus gold and consumer staples versus staples as a sign that the market is not yet losing sight of economic improvement.

Such a rethinking could of course still be ahead. There has been a lot of dissonance in the market messages over the past month. The ongoing two-month cut in mega-cap tech stocks appears to be due in part to the fact that they pushed demand forward in the Covid hunker down quarters. Netflix and Facebook said that too. Meanwhile, Microsoft, SAP, and Amazon indicated slower business spending on tech services.

However, the surge in Covid cases and re-imposed restrictions in Europe and some US states are holding back the most obvious beneficiaries of a return to normal, such as: B. Travel, retail, and restaurant inventory.

The choice is on everyone's lips, of course, but it is difficult to say anything smart about the likely immediate impact on markets – other than to sow hesitation and headline sensitivity in the previous days.

S&P 500 key levels

Fittingly, the market ended last week to maximize the ambiguity. The S&P 500 fell below the 3400 level it barely held the week before, dropping it back into the September correction zone with every trader watching 3230 as the critical level. This is the closing low in September, the high point from June since the first rally after the March low and the break-even line since the beginning of the year.

As if by script, the index fell twice into the 3230s on Friday before rising to 3269 in the last half hour. It's a sloppy looking chart that doesn't deserve the full benefit of the doubt, and some traders are now watching that the 200 day moving average at 3100 is a plausible real test of bull market strength.

Who can say the colliding storms of pandemic, politics, and positioning won't get us there in a more conclusive flush and a flare-up of fear? In markets, trampolines can be disguised as trap doors and vice versa. No wonder people are scared to jump.

Even so, these movements don't always rush to the "what if?" Extremes, certainly not always in a straight line.

The tape is quite oversold through various measures. As of Friday, about half of all S&P 500 stocks were at least 20% below their highs. Stocks did pretty badly as earnings were well above forecasts, but earnings forecasts still held up.

S & P's valuation on earnings estimates for the coming year is by no means cheap, but it's been close to 20 since 23 two months ago. And whatever the chances of getting a Covid vaccine approved now, it's closer and no less likely than a few months ago.

These factors make it a perfectly plausible place for a rebound attempt and suggest that the risk-return tradeoff for long-term investors has improved as stocks have fallen – which is almost a law of nature. Even if the short-term measures on the market are at least as difficult to hinder as elections and pandemics.

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Steven Gregory