Doing what it could to humble the greatest number of people, the stock market followed its ominous downside dump Tuesday with the best two-day surge since the dawn of this bull market.
Among the questions greeting a nervous summer Friday after the S&P 500 jumped 6.4% in two sessions: Do dead cats bounce that high? Another: Are such violent moves a hint of of further pain, or just a passing manic phase?
With stocks still 7% below their recent highs, it seems there are at least three core challenges facing the market: A badly broken trend, the still-dangerous winds of this volatility storm, and the Fed’s response to all the noise.
The S&P 500 (^GSPC) chart is busted.
After months of sideways stasis, stocks have cracked through plenty of trend levels, laying waste to nearly a year’s worth of upward progress in a couple of weeks.
Long-term investors need not care much about the look of a chart, but it depicts a velocity of wealth destruction and an upending of once-reliable trend lines that reassured buyers.
It’s not so much the levels that matter to most investors, but whether the market can absorb further selling pressure and create a trustworthy floor at some level where real money discerns true value. It’s usually a process, not a moment.
The positives: Investors have fled in fear, according to the reports of heavy stock outflows surfacing this morning. Professional money managers have cut back exposure to global stocks to three-year lows, by other measures, which is reassuring from a contrarian perspective.
It’s a decent sign that the most bombed-out sectors got a nice lift Thursday, with energy, commodity and other discarded cyclical stocks boosted. They have much to prove, though, before it’s safe to think they’ve bottomed and aren’t just seeing the short sellers retreat.
A “V” bottom that would take the S&P up and away toward the old highs would not be an unprecedented move – it happened last October. And maybe that would be the trick that would surprise the greatest number of market players. But the more common trend is knocking around, testing the lows, and allowing new market leadership to gather itself for the job.
The volatility storm has imposed alarming damage.
There is a statistical measure of the volatility of stock market volatility known as CBOE VIX Volatility Index (^VVIX), and it has surged off the charts. It’s based on the prices of stock-index options, which have been near the center of this storm.
Hedge funds that try to keep the risk levels of their portfolios in a narrow band have been forced to come up with more cash. Think of the big-money industry as having written a lot of cheap property-insurance policies at the time a huge hurricane hit.
Those policies are underwater and the banks say they need to come up with more cash to cover the policy losses. So they sell what they can and retreat from riskier markets.
This action causes the quicksilver surges and jukes and switchbacks we’ve witnessed. We don’t know who’s trapped or getting squeezed. The more of the purge in stocks has been related to these mechanical matters and not the market’s assessment of the state of the world, the better. Maybe a lot of this risk shock is through by now, but there’s no easy way to make that call.
The Fed’s fix will be in focus for weeks.
The agenda of the Jackson Hole Fed gathering that lasts through the weekend is centered on inflation dynamics in a post-crisis world. But the subtext of the discussion is likely to be about how the economy and markets might absorb the first start of a Fed tightening cycle in 11 years.
No one thinks a quarter-point bump in rates matters terribly much to the real economy or in the way financial assets should be valued. But the message of such a move matters. Do the markets want to hear that the Fed feels their pain and will forestall a move? Do they want the suspense ended and the process underway?
Smart people disagree vehemently on these questions. And they probably won’t quit arguing about them for nearly three weeks, until the Fed meets and we get the answers.
More from Yahoo Finance