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Why stock-market investors fear historic rebound was just a 'wicked bear trap'

MarketWatch logo MarketWatch 12/28/2018 William Watts
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The biggest day-after-Christmas rally in stock-market history wasn’t enough to convince investors that Wall Street has seen the worst of a year-end selloff that’s threatened to end the second-longest bull market. It remains to be seen whether a late Thursday rebound might do the trick.  

The Dow Jones Industrial Average (DJIA) ended higher Thursday, erasing a sharp loss that took the blue-chip gauge down 611 points, or 2.7%, at its session low. The volatile session comes after Wednesday’s 1,086-point rally, a gain of 5%. The S&P 500 (SPX) also followed its tandem 5% jump with a Thursday reversal to the upside, while the Nasdaq Composite (COMP) also rebounded from an initial selloff. Wednesday’s rally had marked a rebound from a Monday selloff that represented the worst Christmas Eve performance for all three indexes in history. 

See: Here’s why the stock market’s big bounce doesn’t mean investors will outrun the bear

It’s been a rough three months, and a particularly difficult December, for stocks, however. The Nasdaq is in a bear market while the Dow and S&P 500 are solidly in correction territory and nursing hefty December losses and year-to-date declines. Some market watchers find big bounces in such an environment less than convincing.

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Russ Mould, investment director at AJ Bell, offered up the table below in a Thursday note. It takes a look back at the 20 biggest one-day percentage gains for the S&P 500 going back to 1970, a stretch that includes nearly 12,800 trading days.

Biggest gains since Jan 1, 1970
Date Daily change in S&P 500
1) 10/13/200811.6%
2) 10/8/200810.8%
3) 10/21/19879.1%
4) 3/23/20097.1%
5) 11/24/20086.5%
6) 3/10/20096.4%
7) 11/21/20086.3%
8) 7/24/20025.7%
9) 9/30/20085.4%
10) 7/29/20025.4%
11) 10/20/19875.3%
12) 12/16/20085.1%
13) 10/28/19975.1%
14) 9/8/19985.1%
15) 5/27/19705.0%
16) 1/1/20035.0%
17) 12/26/2018 5.0%
18) 10/29/19874.9%
19) 10/20/20084.8%
Sources: Refinitiv data, AJ Bell

Bulls can take encouragement from the fact that three of the 17 other days that saw an advance of 5% or more came immediately in the aftermath of the October 1987 crash, “when buying did prove a good plan,” while two more came in March 2009, when the S&P 500 hit bottom and began its current bull run.

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But here’s the rub: Eight of those gains of 5% or more came during the 2007-09 bear market and three more occurred during the downturn of 2000-03, “to suggest there is still a risk that this year’s Boxing Day bonanza could be no more than a wicked bear trap set to lure investors into more trouble,” Mould wrote ahead of Thursday’s open, saying that traders and investors “will be looking out for a couple of further definitive signals before they decide it really is time to buy on the dips following this year’s Christmas selloff.”

Indeed, market veterans warn that massive, one-day rallies are often more characteristic of downturns, occurring as selloffs lead to significantly oversold technical conditions that leave markets ripe for short covering only to give way to renewed selling once the frenzy of forced buying is exhausted. Investors who short a stock are essentially betting that its price will fall by first borrowing the shares, but those traders can be forced to buy shares back if prices suddenly swing higher, which, in turn, can amplify price swings.

On the other hand, stocks did witness a sharp plunge in Monday’s holiday-abbreviated session, with declines of more than 2% across the board amid internal indicators that some analysts said began to show some long-awaited signs of a near-term washout, or so-called capitulation, where the final holdouts during a market downturn finally throw in the towel.

Followed by Wednesday’s robust reversal on “massive” advance/decline volume figures and “surprisingly firm and above average” overall volumes, it’s possible that stocks set a tactical low, though it remains unlikely that an “ultimate low” has been established, said technical analyst Jeff deGraaf, chairman of Renaissance Macro, in a Thursday note.

“How much do we trust the market’s message, up or down, over this holiday week? About as much as we trust uncle Albert to drive home after Christmas dinner,” deGraaf quipped in his research note.

Resistance for the S&P 500 remains at 2,600, admittedly a “big move” from its current level near 2,488, which “also suggests just how much damage has been done in a short period of time,” he said. DeGraaf said structural sentiment data lead him to suspect more weakness is likely in store in 2019 but that “the pendulum that is human behavior is likely to look more optimistically at the beginning of the new year.”

William Watts is MarketWatch's deputy markets editor, based in New York. Follow him on Twitter @wlwatts.

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