The US stock market has performed surprisingly well so far in 2023 despite evidence of slowing economic growth, uncertainty about the direction of Federal Reserve monetary policy, problems in the regional banking sector, and debt ceiling policy in Congress.
S&P 500 index
SPX
It has advanced 7.5% since the start of the year, while the Nasdaq Composite is tech-heavy
COMP
The Dow Jones Industrial Average has recovered 18.5% so far this year
DJIA
It was nearly flat, according to FactSet data.
So why did the stock market fail to fall due to bad news?
Tom Esaye, founder of Sevens Report Research, said negative expectations from both institutional and retail investors were “inadvertently propping up stocks” as the market’s failure to turn back on bad news prompts investors to buy into the stock by underweight investors.
“This dynamic has largely continued and is one of the biggest reasons stocks seem unable to fall on negative news,” he wrote in a note on Tuesday.
Dynamic article description is a market concept called “pain trading” which sometimes occurs when the majority of market participants position themselves in a certain direction, but an unexpected reversal in the market causes huge losses to those who fall on the wrong side.
The concept is based on the idea that the stock market has a higher probability of moving in the opposite direction of the prevailing consensus and a tendency to extract maximum pain from as many investors as possible.
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The S&P 500 fell to a two-year low in October 2022 as investors worried about soaring inflation and steep interest rate hikes from the Federal Reserve. However, even though the broad market index has regained some of its gains in 2023 as inflation eased and the Fed refrained from raising interest rates further in May, the stock market still sees other persistent concerns in the rearview mirror.
Over the past year, institutional investors have pulled nearly $340 billion in assets from the stock market, while individual investors have pulled nearly $30 billion, according to S&P Global Market Intelligence. Meanwhile, money market assets rose to a record $5.3 trillion, according to data from the Investment Firm Institute.
Meanwhile, Essaye said, citing data from Bank of America, that about a third of actively managed mutual funds outperformed the large-cap S&P 500 during the first quarter of 2023.
The recovery in the S&P 500 has left investors and many active managers “less invested and an underperformer” of the S&P 500, Essaye wrote.
In this case, the pain trade is for the stock to move up when a large number of market participants remain bearish.
“That’s why the higher pain trade remains so strong and the net result is that the longer the long list of what ‘can’ go wrong’ doesn’t ‘go wrong’, the greater the pain felt by managers who don’t invest and underperform, and the more upward ‘fuel’ there will be for the rise. market, as these managers chase the stock higher to increase provisions.”
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As a result, if investors receive material negative news, for example, a hard landing for the economy, a rebound in inflation, another hike in Fed rates, or a breach of the debt ceiling, then “none of those sentiments matter — it will go down,” Essaye said. The S&P 500 is falling sharply.
However, if all the bad things don’t materialize, the stock market’s ability to rise remains stronger because it will be supported by under-invested traders, which makes the market jump higher, Esaye said.
US stocks traded mostly lower on Tuesday as investors weighed on data on April retail sales as they awaited another round of debt ceiling talks between President Biden and Republican policymakers.
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