The Roller Coaster Continues Despite Monday’s Staggering Recovery

Despite Monday’s nearly historic price swing that left the major indices closing in the positive, equity index futures were pointing lower on Tuesday. The Federal Reserve starts its two-day meeting today and its announcement will be given on Wednesday. Stock valuation are still up in the air, and there’s a slew of earnings announcements for investors to weed through.

A number of companies have beat earnings estimates but missed on revenues. These include Johnson & Johnson (NYSE:), NextEra Energy (NYSE:), Raytheon (NYSE:) and General Electric (NYSE:). JNJ fell 1.15% in premarket trading, NEE was down 2.34%, RTX dropped 3.54%, and GE traded 2.57% lower. JNJ is still preparing to split into a consumer products company and a pharmaceutical company.

However, Verizon (NYSE:), American Express (NYSE:), 3M (NYSE:) and Lockheed Martin (NYSE:) beat on top- and bottom-line numbers. VZ increased its forward earnings guidance, which also helped the stock rise 0.47% in premarket trading. AXP also rose on the news in premarket, up 0.61% after seeing a new record in credit card spending. LMT reaffirmed its 2022 sales outlook, which helped the stock rise 0.50% before the bell. MMM contributed its success to its customer focus and the ability to manage supply-chain issues which led to the stock rallying 1.75% before the bell.

After the bell, Microsoft (NASDAQ:) and Texas Instruments (NASDAQ:) will announce earnings. These two announcements will provide insights into two volatile areas of the market—software and semiconductors. Microsoft may set the tone for the other mega-cap stocks scheduled to announce this week.

The Cboe Volatility Index () spiked 12.5% in premarket trading, reflecting the rising uncertainty among investors that the bargain hunting may not continue. The rallied 1.56% before the bell, while was slightly higher a 0.30%.

Mercurial Monday

Stocks started the week in a downslide, with the falling nearly 4% after the open. However, small-caps stocks started the intraday recovery with the bouncing off its morning lows after falling 5.5% in the morning. The small-cap index rallied back into positive territory and closed 2.29% higher thanks in large part to energy stocks. The S&P 500 and the were also able to bounce off their lows to close in positive territory.

The massive sell-off and recovery could be the sign of capitulation that investors have been hoping for. When finally backed into a corner with what appeared to be real panic selling, bargain hunters seem to have stepped in and started buying. It could also be a good sign that investors started their bargain hunting with the riskier small-cap stocks demonstrating that these stocks have fallen to valuations where the risk is low enough to make the companies worthwhile. Even bitcoin rallied to positive territory alongside small caps, reflecting the change in appetite for risk.

Hopefully, over the next week, the larger companies can demonstrate greater strength. They could get some help from stocks because half of them report earnings this week. In fact, International Business Machines (NYSE:) reported after the closing bell and rallied 6.79% on the news that the company beat on and revenue forecasts. The company had been working on a turnaround plan that appears to be taking shape particularly in its cloud services division. The Dow Jones closed in the green despite being down 1,100 points intraday. It was helped by Home Depot (NYSE:), which traded 4.21% higher on the day.

Despite the enormous rally to end the day, there’s no reason for volatility to fade. The bears could strike back later this week over concerns about earnings for technology companies, particularly those that deal in the cloud. Fortunately, IBM was able to show progress in its cloud business, but Microsoft had a range that stretched more than $20 on Monday.

The problem comes with rising rates and investors still trying to determine valuations. Pandemic plays were all over the map, with Netflix (NASDAQ:) falling 11% to close down 2.60%. Zoom Video Communications (NASDAQ:) rallied 3.58%. Peloton (NASDAQ:) rallied 9.79% as activist investors cry for the CEO to be fired and the company be sold. Finally, DocuSign (NASDAQ:) also fell more than 7%, but closed 4.91% higher.

Correction Versus Bear Market

As previously noted, the Nasdaq is in correction territory. A correction is classified as a market pullback between 10% and 19%. A bear market is a declining market that has dropped 20% or more. The small-cap index was down about 20% at its intraday lows on Monday, which would’ve put it in bear market territory. All other major indices including the S&P 500 and Dow Jones Industrial Average are near correction territory.

A correction can be quite healthy for stocks in that it helps weed out overvalued companies and allows other stocks to revert to their earnings means, or in other words, trade more in-line with their actual earnings growth. A bear market is different in that it tends to signal that there may be something wrong with the underlying economy. Stocks are commonly said to run about six months ahead of the economy.

The VIX can be helpful in signalling a correction versus a bear market by paying attention to certain levels. In 2021, market pullbacks often turned around when the VIX was near 30 (see below). However, in 2020, that level was around 40. And that 40 level stretches back into the previous two decades. The dot-com bubble burst and the bear market bottomed out soon after the VIX hit 40. But the 2008 credit crisis changed everything. The VIX can now spike above 40 during a correction, and the last two bear markets saw spikes around 90 before creating bottoms.

VIX Daily Chart.

CHART OF THE DAY: THE RUB ON THE VIX. The VIX, or Cboe Market Volatility Index (VIX), has broken above its 2021 reversal level (red line upper chart) and is testing a long-term reversal level (blue line in both charts). Data Sources: ICE), S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Language Barrier: The world’s central banks don’t appear to be speaking the same language as the U.S. Federal Reserve is talking about tightening the U.S. money supply. European central banks are holding off on tightening as long as possible. And Asian central banks are increasing their money supplies to stimulate their economies.

The Federal Reserve is meeting this week to discuss its monetary policy plans. The Fed has greatly reduced its bond-buying stimulus efforts and should quit them entirely by March. Then the markets are expecting the Fed to increase the overnight rate by a quarter of a point in March. This is because the Fed is concerned that the higher rate of inflation is at risk of becoming structural and not transitory.

Drawing Borders: European Central Bank President Christine Lagarde has rejected calls to increase rates to combat soaring inflation and prefers to wait on the inflation problems correcting themselves as supply-chain bottlenecks open up and producers get back to work when COVID-19 restriction are lifted in Europe. The largest increases in prices have been due to energy prices, so getting through the winter months could also be a big help. Lagarde stated that an important difference is that Europe isn’t seeing the “excessive demand” that the United States is.

Last week, the People’s Bank of China cut a couple different interest rates to try and stimulate economic growth. China isn’t seeing the same degree of inflation because consumer spending has slowed, regulations have tightened, and the property sector is struggling. The housing market has been troubled by over-borrowing from homebuilders and now they need to refinance the debt to lower levels, so it becomes more serviceable.

Opposing Forces: These conditions are likely to push the higher, which has normally been a drag on large- and mega-cap international companies and help domestic small-cap companies. Perhaps this morning’s small-cap led rally is a good sign that investors are recognizing the favorable position for the group.

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