Palumbo Pulse July 15th, 2024: Extremes

The Billy Joel channel is back on Sirius XM this month (channel 79, if you care) and it has become my go to channel in the car. Thursday, on my way home, they played “I go to Extremes” and I couldn’t help but think about the stock market.

Markets tend to go to extremes, both high and low, which are simply a measure of the collective greed or fear, as the case may be. After the massive AI driven run up in equity prices, on Thursday, there was a first taste of palpable fear. It didn’t last long, as Friday reversed course back to the upside. Is there room for this bull to run further? Could be, but there is this concept of ‘reversion to the mean’, which could stand in the way. Reversion to the mean simply means that the market does not move too far away from the mean (average) before it is pulled back to toward the mean. Of course, you never know when that will happen, you just know that it will.

On the chart below, the pink line is the 50 day moving average (each point on the line is the average price of the prior 50 trading days) and the purple line is the 200 day moving average. There are about 250 trading days in a year, so the 200 day average is about the last 9.5 months of trading.

What is getting interesting is that the market is far above both the 50 day and the 200 day average. I don’t know if the market moves higher from here, or if Thursday was the beginning of a more serious correction. What I do know is that reversion to the mean is real and the index level is moving further and further from the mean. At the time this was chart was produced (from Fidelity) on Friday, the S&P 500 index was about 14.5% above the 200 day moving average. That is not a record. It has been higher, but nonetheless, it is in rarefied air. The point is that it takes a 15% correction just to get back to the mean.

And we know the market often goes to extremes on the downside too, which we can see on the left side of the chart, where the index is well below the 200 day average. The point is simple. While this bull run can certainly continue, it is getting long in the tooth and some caution for traders is warranted.

The Next Hurdle

The next hurdle is probably second quarter earnings, which will be reported over the next 3 weeks or so. The market has been lea by the mega cap tech stocks; the AI leaders. But the year over year comparisons are beginning to get tougher, and the market wants to see return on investment these companies. The last few quarters have set expectations very high. Any failure to hit those expectations should be expected to elicit a harsh response in the stock market. It would be very hard for the index to continue the rally if a few of the Magnificent 7 stocks had earnings disappointments, catalyzing a reversion to the mean.

“Darling, I don’t know why

I go to extremes

Too high or too low

There ain’t no in-betweens

You can be sure when I’m gone

I won’t be out there too long” – Billy Joel

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What We’re Reading

Good news: Inflation falls 0.1% in June from prior month

Bad News: Wholesale prices rose 0.2% in June, slightly hotter than expected

Biden Vows to Stay in Race as Questions Swirl

Is a stock-market rotation under way? Small caps surge

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?The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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