Traders whose bullishness on the Standard & Poor’s 500 Index (SPX) surged to the highest levels in 12 months last week finally got a break.

U.S. stocks rallied for the first time since the start of the year yesterday, rising 1.2 percent after suffering the fifth decline of 4 percent or more since last January. Relief that Federal Reserve minutes signaled no change in interest rate policy and optimism on employment growth helped break an 88-point slide in the benchmark gauge for American equity.

That was overdue news for speculators who had cut bearish bets on the SPDRS&P 500 exchange-traded fund to the lowest in a year and built long positions in futures to a 12-month high, data compiled by Bloomberg showed. The rebound came after trading in contracts tied to equity volatility flashed a signal on Jan. 6 that five days of selling had gone on too long.

“We’re trained like Pavlov’s dogs,” John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management in New York, said in a phone interview. “It’s been a little bit of a rubber-band phenomenon for the past six months or so. The market was thirsty for news, and we got some today.”

The S&P 500 rallied the most in three weeks yesterday. It rose at the market’s open as data on the labor market and the U.S. trade deficit bolstered confidence in the strength of the economy. Gains extended at midday as lawmakers in Chancellor Angela Merkel’s coalition said Germany is leaving the door open to debt-relief talks with Greece’s next government.

And:

The five-day, 4.2 percent slump in the S&P 500 came just 13 days after the index dropped 5 percent between Dec. 5 and Dec. 16. The span between the two dips was the shortest since two retreats of more than 4 percent in late 2011, data compiled by Bloomberg show. Since 2009, retreats of this magnitude have happened every 51 days, on average.

David Fuller's view

That last sentence above provides more than enough evidence for a ‘buy the dips’ conditioning process.  Moreover, throughout most of this nearly six year bull market to date, plenty of investors have either lost money by shorting too aggressively or missed out on big gains by taking profits too early. 

The speed of the recent rebounds indicates that there is still significant buying power underneath the market although this will not always be the case.  Danger signs will be a particularly strong rally which thins out demand, followed by an even sharper retreat.  Additionally or alternatively, we will see rallies weaken, causing lower highs and lower lows to occur on indices.  Those, of course, would provide evidence of medium-term downtrends. 

Meanwhile, more investors appear to have realised that low energy prices due to oversupply are considerably more bullish than bearish for the global economy.  However, while the benefits are spread widely over time, disasters for the most vulnerable oil producers will occur more quickly, making them newsworthy.  Some will default.  Also, there is a risk that Putin does something really dangerous, possibly in an attempt to lift the oil price. 

Nevertheless, the key point for investors to keep in mind is that there is no such thing as a risk free environment, in investments or life in general.  So maintain a healthy lifestyle, aided by an equally healthy portfolio, consisting of sensible, proven funds or investment trusts, and Autonomy-type shares with reasonably good dividends.  Try not to chase uptrends in a six-year old bull market.  Reasonably active investors will generally do better by lightening on persistent strength, rather than selling following a shakeout.

The investment environment remains generally favourable, in my opinion.  What I have always feared most in stock markets is tightening monetary policy, but we do not see that at present.  Moreover, the Fed will most likely proceed very cautiously when it does begin to lift short-term rates.  Bond market yields are benign, to put it mildly, and exaggerating deflationary risks, in my opinion.  There is an unaccustomed positive deflationary influence in this cycle, coming from technology.  If investors accept that stock markets will often be volatile, they will be emotionally predisposed to benefiting from that environment.   

Lastly, the two most important factors for the secular bull market that we have been forecasting are the accelerated rate of technological innovation and lower energy prices in real terms.  As veteran subscribers may recall, during the last five years I have been talking about evidence of a secular bull market before the end of this decade.  When I mentioned this in public venues, expectations were so low that thoughtful people were bemused or even embarrassed on my behalf, particularly over the forecast of lower oil prices before the end of this decade.  This has happened sooner than I expected, thanks to technology, and OPEC is effectively finished as the controlling force for oil prices, in my opinion.  Nevertheless, I think it would be premature to conclude that we are in a secular bull market until we have seen the successful normalisation of interest rates, which I expect.  That process will result in some market turbulence but the key factors for a multi-decade bull market are in place.