Bulls Give Evidence of Life as S&P 500 Posts Best Week of 2016

  • S&P 500 jumps 2.8 percent in best week since November
  • Banks, retailers further recover from steep losses this year

Just when it looked like U.S. stocks were doomed to follow the rest of the world into a bear market, buyers emerged in a holiday-shortened week, lifting equities out of their deepest hole since 2014.

Improving economic data and the worst sentiment readings in three years combined to ignite the biggest weekly rally for the year for the Standard & Poor’s 500 Index, including the first three-day stretch of 1 percent gains since 2011. Losses on Thursday and Friday did little to overturn an advance that was led by banks, oil companies and other beaten-down industries. 

“It suddenly looks like people are starting to dig around for babies thrown out with the bath water,” said John Stoltzfus, the New York-based chief market strategist at Oppenheimer & Co. “In the last eight days, we’ve had a significant reversal from risk off to risk on, with investors appreciating sectors that are cyclical facing. Sentiment has moved away from overwhelmingly negative to skeptical.”

The S&P 500 gained 2.8 percent to end at 1,917.78, as the strongest weekly gain since November helped recoup a portion of the $2 trillion of U.S. equity value that had been erased in 2016. The benchmark still sits 10 percent below its May high. The Nasdaq Composite Index advanced 3.9 percent, the most since July, while the Dow Jones Industrial Average gained 2.6 percent.

To understand why stocks surged, it helps to realize how sour sentiment got in the previous week. A survey of newsletter writers by Investors Intelligence showed the lowest spread between bulls and bears since April 2013. Short interest in American stocks climbed to an average 4.3 percent of shares available to borrow at the end of January, a level reached only one other time since 2008, according to data compiled by Bloomberg. The VIX Index of market stress reached the highest in five months on Feb. 11.

Valuations may have helped. After the S&P 500 plunged to a 22-month low on Feb. 11, the gauge’s price-earnings ratio fell to 16.5 times. That level has served as a rally point six times since February 2014, halting selloffs among U.S. stocks, according to data compiled by Oppenheimer.

There was evidence that investors were searching for bargains after the prior week’s losses. Financial companies, the most beaten-down group in the S&P 500 this year, were lifted 2.5 percent in the four days ending Friday. Other hard-hit sectors staging a comeback included consumer discretionary shares and technology, which led gains as all 10 main industry groups advanced.

Markets saw a weakening in the lockstep moves that have paralyzed investors this year. Thirty-day correlations between the S&P 500 and 10 other asset classes, including oil, whose sway on stock investors was pervasive in January, have fallen in the past two weeks, data compiled by Bloomberg show. As recently as the beginning of this month, equity gauges around the world were moving broadly in tandem -- in several cases by the most in seven years.

“What we need to see is the market shift from a focus on oil being the harbinger of an economic slowdown to the U.S. consumer data, which seems to be improving with every release,” said David Schiegoleit, managing director of investments in Newport Beach, California, at the Private Client Reserve of U.S. Bank, which oversees $125 billion in assets. “That could turn lower oil prices from a headwind into a tailwind. The market has not been trading off of fundamentals. The market has been trading off of fear and trying to read the tea leaves of falling oil prices.”

Economic data helped calmed fears of recession, at least for now. A report on Friday showed the cost of living in the U.S. increased in January by the most in more than four years while earlier data on manufacturing came in better than expected. Federal Reserve minutes also offered relief for a nervous market, signaling the bank could delay its plans for tighter policy to assess how the economy reacts to current headwinds.

Measures of investor anxiety reflect fear’s loosening grip. The Chicago Board Options Exchange Volatility Index fell 19 percent after posting steady gains in the first two weeks of the month.

Companies with the highest short interest were also among the best performers. Chesapeake Energy Corp., the third most shorted stock in the S&P 500, posted the second best weekly gain among the gauge’s other members. A Goldman Sachs Group Inc.’s gauge of the most shorted stocks saw its best weekly advance in over a year, rising 5.2 percent. With riskier assets rallying, investors are covering their short positions, said Bruce Bittles, chief investment strategist at Milwaukee-based Robert W. Baird.

“The pessimism in the market got so excessive in early February, a lot of folks were shorting stocks and the short interest built up,” Bittles said. “When the market turns, those people get the most nervous and they are the first to buy.”

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