Much of the time, it’s folly to say why the market goes up or down on a particular day. As Barry Ritholtz points out, journalists need to sell papers (or get clicks), and headline explanations of why the market is up or down is necessary to that end. Even if it’s spurious, or untrue.
With the S&P 500 (SPY) hitting new highs and 1900 looking doable by summer, finance journalists are looking for a headline. Bloomberg has written that stocks are rising on U.S. optimism—a vague term that, really, just means bullishness. So stocks are up because people are feeling bullish. It’s a truism, and not an illuminating one.
Professional money managers’ and analysts’ job is to cut through the popular headlines and the ulterior motives of people like financial journalists to get to the real truth of the trend. Often, again as Ritholtz points out, a bullish or bearish day is coincidental—it’s a result of certain institutions moving money from one asset class to another based upon clients’ interests or requests.
This random capital flow based upon client needs is one cause for the rise in stocks on Monday. But what is behind that capital flow?
Last week, Friday was a bearish day when the S&P 500 flirted with 1870, with the index barely 1% up YTD. With that low price point, investors looking to buy into the market saw a “buy the dip” opportunity that caused capital to flow into the market on Monday.
Another motivation behind the capital flow may be a rotation out of momentum stocks, which have strongly underperformed in 2014 as investors de-risk their portfolios. With many high-beta stocks strongly negative YTD, investors who have sold those low growth stocks look for higher quality alternatives. This is why the Dow Jones (DIA) is up YTD and the Russell 2000 index (IWM) is down over 2.5% YTD. In relation to this trend, we may be seeing a correction to the bearishness in momentum stocks that is pushing up the market more broadbly, as IWM rises over 2% on Monday, after being down over 4.5% YTD by Friday’s close.
That derisking also points to a third cause for the capital flows, which circles back to Bloomberg’s assertion of optimism: this derisking out of high-beta stocks with low or negative earnings that are up many multiples in recent months or years is a sign of a healthy investment atmosphere. It means people are not causing asset bubbles in questionable businesses, which makes investing in the market more broadly attractive.
A fourth and interesting but largely unnoticed cause of this bullishness goes back to overall valuations and the earnings season. Earlier in the year, many investors feared we were hitting a P/E ratio of 20 for the S&P 500, a sign of a dangerously overvalued market. But earnings rose higher than expected in the last earnings season thanks largely to stock buybacks, leaving the P/E ratio closer to 18.6—still high historically, but not much higher than in May 2013, after which time stocks rose at an incredible pace.
It isn’t always easy to understand a day’s price action, and often it is impossible, with explanations more the result of pattern recognition and wishful thinking. But today, it’s clear: the confidence in a low risk market, the correction of oversold small-caps, the rotation into large-caps, and a manageable P/E ratio are helping stocks have a good start to the week.