The Stock Market Meltup of 12/26/2018

As Brian Williams of MSNBC likes to say, “well, that gets your attention.” Today’s market action was truly remarkable in several ways. I will try my best to dissect what happened, and what it may mean going forward.

Let’s start with the raw numbers from today and place them in the context of market history going back to 1950. The question I want to answer is this: How powerful was today’s rally in the context of historical one-day rallies?

Here are the numbers.

 

stock market meltup december 26 2018

 

Here are my observations.

Today was the 18th biggest 1-day rally since 1950. That puts today in the top one-tenth of one percent of all 17,200 trading days in the data set. 

Today’s rally was a 5 Sigma event. Very rare in any statistical study. What this means is that today’s rally was five standard deviations away from normal. (One standard deviation is a price change of plus or minus 0.95%)

Since today’s rally is now in the record books as one of the elite market events in history, professional traders and portfolio managers will be telling stories about it for decades to come. 

When you look at the date column you will see that the majority of these elite market events happened during just a few periods. Specifically, the Global Financial Crisis of 2008, the Crash of 1987, and the bursting of the Tech bubble in 2001.

After these one-day super rallies, the market was essentially flat one month later. Three months later the market was down about 2%. But here’s the big takeaway: one year later, the market was up by 20% on average. This is understandable since these big up moves mostly happened during huge bear markets. 

What caused this historic rally?

Based on my conversations with professional traders and portfolio managers I have come to the conclusion that today’s rally was the mother of all oversold bounces. The market was extremely oversold, and it was time for the big short sellers to buy back their positions. But there were no offers. Any time a market has no bids or no offers, the result is a 3, 4, or 5 standard deviation event. 

Today it was the short sellers who were in the barrel, as they desperately tried to buy back their short positions in a market where the sellers were on strike. 

What happens next?

With the standard caveat that nobody really knows what comes next, I do have an opinion. A rally like we saw today simply can’t be sustained for very long. There might be some follow-on buying tomorrow, but nothing on the scale of what we saw today.

What’s more interesting to me is the prospect of what things will look like 12 months from now. The historical record says that the market will be 20% higher one year from now. There were only two years where the market was lower. That’s pretty strong evidence that the odds favor a higher market by Christmas 2019.

This correction is far from over.

A one-day rally, even one that is as powerful as this, does not mean that the correction is over. Keep in mind that most of the buying today came from short covering and algo traders that rode the wave higher. Tomorrow morning these folks are going to wake up and say, “I took my lumps, and I’m going to stay on the sidelines for a few days and see what unfolds.” 

To me, that means that the buyers will be much more scarce in the next few days. And that means that the next few days will probably belong to the sellers who are doing year-end portfolio adjustments. And that means there will be more sellers than buyers between now and New Years Day.

The line in the sand.

The line in the sand for the S&P 500 is crystal clear. It’s 2,344. That is the demarcation between a correction and a bear market. I don’t know if we will cross that line in the sand, but if we do, the shorts are likely to reappear to take advantage of it.

 

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