The US stock market has done surprisingly well so far in 2023, despite evidence of slowing economic growth, uncertainty over the direction of the Federal Reserve’s monetary policy, problems in the regional banking sector and debt ceiling policy in Congress.
The S&P 500 SPX,
has advanced 7% year-to-date, while the tech-heavy Nasdaq Composite COMP
has recovered 17.9% so far this year and the Dow Jones Industrial Average DJIA,
is down 0.4%, according to FactSet data.
So why hasn’t the stock market fallen on bad news?
Tom Essaye, founder of Sevens Report Research, said negative expectations from both institutional and retail investors were “unintentionally supporting stocks” as the market’s failure to bearish on bad news prompts buying of investors who are underweight stocks.
“This momentum has largely continued and is one of the main reasons why stocks can’t seem to fall on negative news,” he wrote in a note on Tuesday.
The Dynamic Trial described is a market concept called “pain trading” that sometimes occurs when most market participants have positioned themselves in a certain direction, but an unexpected market reversal results in significant losses for those who they are caught on the wrong side.
The concept is based on the idea that the stock market has a higher probability of going against a prevailing consensus and a tendency to extract the most pain from as many investors as possible.
I will see: Why Bears Can’t Keep the Stock Market Down Despite Bad News
The S&P 500 fell to a two-year low in October 2022 as investors worried about high inflation and aggressive interest rate hikes by the Federal Reserve. However, while the broad market index has regained some ground in 2023 as inflation has eased and the Fed refrained from raising interest rates further in May, the stock market still sees other lingering concerns in the rearview mirror.
Over the past year, institutional investors have pulled nearly $340 billion in assets from the stock market, while individual investors have pulled nearly $30 billion, according to S&P Global Market Intelligence. Meanwhile, money market assets have soared to an all-time high of $5.3 trillion, according to data from the Investment Company Institute.
Meanwhile, only about a third of actively managed mutual funds outperformed the large-cap S&P 500 in the first quarter of 2023, Essaye said, citing data from Bank of America.
The S&P 500’s recovery has left investors and many active managers “underinvested and underperforming” the S&P 500, Essaye wrote.
In this case, the pain trade is for the stock to go higher when a mass of market participants are still bearish.
“That’s why the pain trade remains solidly higher, and the net result is that the longer the long list of what ‘could’ go wrong ‘doesn’t’ go wrong, the more intense the pain that managers feel with underperformance and underperformance, and the most ‘fuel’ to the upside will have a market rally as these managers chase higher stocks to increase allocations.”
I will see: That’s the big thing holding up the stock market, says Bank of America
As a result, if investors receive significant negative news, such as a hard landing for the economy, a pick-up in inflation, another Fed rate hike, or a debt ceiling breach, then “none of that sentiment matters … the S&P 500 is going to fall, and it’s going to fall hard,” Essaye said.
However, if all the bad things don’t materialize, the stock market’s ability to bounce back remains stronger as it will be fueled by underinvested traders, sending the market higher, Essaye said.
US stocks ended sharply lower on Tuesday as investors weighed April retail sales data as they awaited another round of debt ceiling talks between President Biden and Republican policymakers.
