The US stock market simply will not be defeated.
But why? There’s not anything particularly bullish happening in the earnings world, and there’s been no major economic data released.
One explanation is that traders have simply pushed aside their worry over possible military action between the US and North Korea, and are using last week’s weakness as an attractive entry point for more stock buying.
If that reasoning sounds familiar, that’s because it’s happened time and again throughout the eight-year equity bull market, which is now well into its tenure as the second-longest on record.
Stock traders seem fully aware that brief selloffs in the last several years have simply been head fakes, and are treating them as nothing to worry about. In fact, their willingness to recognise and apply that logic may even be helping fuel the trend further.
“Last week’s action was more investors taking advantage of news that justified some profit taking, rotation and rebalancing rather than a market rout or harbinger of worse things to come,” John Stoltzfus, the chief investment strategist at Oppenheimer, wrote in a client note. “While markets may be rattled by spikes in tensions between nations and even war, the unsettling periods for the bourses around these occurrences tend to be short in duration and with fleeting effect.”
For evidence of how quick US equity investors are to buy the dip, look no further than the S&P 500’s 1.8% single-day decline in May. The index recovered 85% of that loss over the following three days, the second-fastest retracement of a loss that big in S&P 500 history, according to data compiled by Bank of America Merrill Lynch.
Going further back in time, after the S&P 500 fell by 5.3% over two trading sessions following the UK’s vote last June to leave the European Union, the benchmark recovered those losses in about a week.
The same dynamic was in play when China unexpectedly devalued its currency in August 2015. After the S&P 500 underwent an 11% correction, traders bought the dip and restored the benchmark to its pre-sell-off levels within about two months.
Torrid earnings growth for S&P 500 corporations is at the root of stock investor confidence right now. Companies in the benchmark index are on pace to expand profits by 10.7% in the second quarter, which would mark its fourth straight period of expansion, according to survey data compiled by Bloomberg. The S&P 500 is expected to grow earnings by 11.2% in 2017, its best full-year performance since 2010, the survey shows.
So what will finally serve as the tipping point for US equities? No one knows at this point, but keep a close eye on the CBOE Volatility Index, or VIX, which serves as a measure of stock market fear. The gauge — which trades opposite the S&P 500 roughly 80% of the time — spiked 44% on Thursday, but has since pared that gain.
While that price action in the VIX isn’t particularly worrisome to Allianz chief economic advisor Mohamed El-Erian, he’s not ruling out more price swings if the ongoing geopolitical griping escalates further.
“The market’s buy-on-dips conditioning is strong,” El-Erian told Business Insider. “As such, it would take a worsening of the North Korean tensions to amplify the pressures on the VIX.”