The Rudolph Rally

One of the characteristics of a momentum driven market is that traders chase moves, both up and down.  We saw the latter on Wednesday, when the market tanked.  We saw it yesterday morning when a modest rally metastasized into a nearly 1% move before fading on a lack of follow-through.  And we see it this morning.  After the early selling abated, a modest rally turned into a sizeable upswing.

The interesting part is that both Friday’s and today’s moves are a bit out of proportion with the news.  Wednesday’s FOMC meeting was certainly the cause of the jitters.  But as we pointed out yesterday, the basic elements of the FOMC’s actions were almost exactly what the markets were expecting beforehand – a 25bp rate cut and guidance that pointed to only two cuts in 2025.  Yet some of the underlying data in the Summary of Economic Projections (SEP) and commentary from Chair Powell spooked the bond market to a greater degree than the headlines would have indicated.  That led to higher yields, which led to a stronger dollar, which led to pressure on multinationals, which then spooked an equity market that had been displaying some cracks under the surface.  We concluded Tuesday’s piece with:

                They [markets] may not be fragile, but they’re certainly not “anti-fragile.”

It turns out that there was some fragility, and the selling began to feed upon itself.  That’s momentum at work. 

This morning’s activity, however, is what we see when FOMO powers the momentum.  Stocks opened lower after disappointment that the hoped-for resolution to avoid a government shutdown failed last night.  But just as yesterday’s attempted rally failed when there was no follow-through – and the stubbornly high level of VIX was a “tell” that nerves were still frayed yesterday – today’s selling also ran out of steam.  It’s understandable why buyers would have stepped in – that’s what good traders do.  What’s less understandable is why we now see an across-the-board rally of about 1.8%. 

That’s where the FOMO comes in.  It’s one thing to hop on a rally, another thing to chase it relentlessly.  The news flow this morning has been mildly positive, with slightly better PCE readings that took pre-market futures off their lows, and a mixed UMich Consumer Confidence report at 10am.  The rally began in earnest after the numbers, but not for about 15-20 minutes.  There have been some rumblings about the potential for a Congressional deal, but nothing substantive.   Bond yields have declined by about 4-7bp, so that’s a positive, but not enough to propel a monster rally.

No, this was about momentum writ large.  Those who sold into the decline or missed the opportunity to buy at the lows seemed to return with a vengeance. The fact that it’s a quarterly expiration Friday certainly abetted the potential for a big move, since we have literally thousands of possibilities for a rally to push stocks through expiring strikes.  And there is a definite “What Me, Worry?” characteristic to the move, with VIX collapsing from 24.09 to 18.34.  We’re not back to full complacency, but the sizeable backwardation in VIX futures is now gone, meaning the excess demand for volatility protection is now gone.

Of course the final theory for the ferocity of today’s rally could be the desire to front-run Santa Claus.  Before this week’s bout of volatility, the consensus was for a placid, upward end to the year.  It’s clear that many have returned to that type of thinking.  I’ll call today’s move the Rudolph Rally, where people have decided that they now have the ability to see through whatever holiday murk might have inhibited the markets before today.