Yesterday was a dramatic day for the S&P 500 in this holiday shortened week. A NATO nation intentionally shot down a Russian fighter jet and fears of a military escalation sent traders scrambling for cover. European markets plunged 2% on the news and the selling spilled over to US markets when we opened.
But by midmorning the reactive selling stalled and we found support at 2,070. Not only did the market find a bottom, but by the close we recovered all the losses and finished in the green. Without a doubt this counter-intuitive price-action left a lot of bears scratching their heads.
Russia is clearly upset about what happened and the world is anxious to see what happens next. Realistically Putin only has two options, retaliate or complain. While a military escalation between Russia and the West is terrifying to contemplate, Russia would suffer tremendously if he chose this route. Putin is most definitely a bully, but he is not a madman.
He has little to gain from a direct confrontation with NATO and everything to lose. Inflammatory rhetoric is the only sensible tool for him to wield because he cannot afford to do any more. Maybe he could withhold oil and natural gas, but even that is cutting off his nose to spite his face because this would do far more damage to the Russian economy than Europe. Traders waking up to this realization is what allowed us to recover from those early, reactive losses.
Since this is a holiday week, most big-money, institutional investors are on vacation. Without their guiding hand, we often see increased volatility as smaller and more impulsive traders take over. Had these events occurred during a more typical week, most likely we would not have fallen as far since cool-headed money managers would have snapped up the irrationally discounted stocks.
Without big money’s help yesterday morning, the only thing that saved us was running out of sellers. The thing that kept these losses relatively modest was the fact that we’ve seen a tremendous amount of turnover through the last few months. August’s plunge purged most of the weak-kneed owners and replaced them with far more confident dip-buyers. Anyone who bought the fear and uncertainty over the last few months clearly has thick skin and they demonstrated that again yesterday by not reacting to the morning headlines. While most people are confused by the market’s reaction yesterday, if you understand the underlying factors, this modest dip and decisive rebound make perfect sense.
As for how to trade this, it is hard to get more bullish than this type of response to bad news. If we won’t sell off on falling energy prices, slowing global growth, a surging dollar, disappointing earnings, rate-hikes, terrorism, and now military conflict with Russia, it is hard to imagine a scenario that will scare these confident owners into selling.
Bearish headlines don’t matter if no one sells them. Given this environment, plan on another Santa Claus rally this December.