Three weeks into February, many investors are still wincing at the wild market conditions that erupted last month when Robinhood account holders — high on stimulus checks — declared war on the hedge fund establishment.
Trading conditions occasionally got a little wild, triggering flashbacks to the sudden COVID-19 crash nearly a year ago. As a result, some people on Wall Street remain somewhere between wary and traumatized.
But how much of that caution is a function of sentiment and how much is real market stress? And more importantly, have stocks recovered their balance even if shareholders are tense?
Wall Street has developed tools to answer these questions. We can measure market strain and weigh it against historical trends.
When you do that, you’ll see that there are plenty of opportunities to exploit when your fellow investors get nervous.
Statistics Can’t Spin
I incorporate a lot of statistical analysis into my investment strategies because while sentiment always has an irrational component, numbers can’t lie.
And numbers obey their own laws that, over time, are as close as it gets to unbreakable. Any given day on Wall Street can be as surprising as meeting a unique human being, but in the long haul, extremes get averaged out.
Stocks can rally and plunge for no discernable reason. That’s sentiment at work, not to mention the external factors that force investors to buy or sell against their best interest.
But unless there’s a tangible cause for stocks to move, they inevitably revert to the trend. Those trends are moving, so sometimes the trend catches up to the stock.
Usually, it’s the other way around. And here’s the kicker: similar rules apply to the amount of volatility within the market itself.
We can chart the trend on the CBOE Volatility Index (VIX), or “fear index.” On those terms, it’s clear that the Robinhood revolution only quickened the market’s pulse a bit.
Wall Street is still far from showing the kind of stress we saw last year. In fact, I think a little activity is good for us all.
Naturally, I don’t want you to just take my word for it. The S&P 500 moved 1.25% a day between its intraday low and high in January. That’s a little less than average.
Intraday volatility was slightly more intense in November. It only felt extreme in the wake of a truly quiet December, when a lot of investors were effectively on vacation.
In other words, all the frenzy over “meme stocks” failed to register on Wall Street as a whole. Companies like GameStop Corp. (NYSE:GME) and AMC Entertainment Holdings Inc. (NYSE:AMC) simply don’t move the overall needle even when they surge hundreds of points in a given day.
Every time a true market heavyweight like Apple Corp. (NASDAQ:AAPL) moves $0.65 up or down, $10 billion in wealth is created or destroyed. That’s enough to buy every share of five companies AMC’s size.
Individual stocks, like people, can have great days and terrible ones while the market as a whole barely budges. January barely budged the S&P 500 into a 1% decline.
Again, that’s far from the end of the world. Of course, we don’t trade the market as a whole in my world. We prefer to pick and choose individual stocks with the potential to give us those great days.
GME and AMC are a long way from truly great operating conditions. They can’t support the hype and as a result, the stocks have reverted to trend now that sentiment has cooled.
I wouldn’t be surprised to see GME in particular retreat below $20 at least briefly. This is not an entry point. Frankly, I’d rather park my money in the S&P 500 while I wait.
The Real Opportunity
But statistical analysis also has a predictive quality. We can match current market conditions to historical data and see more or less where any given setup can go.
Of course, we’ll never be able to forecast the future with perfect precision. This is more of a way to control our own expectations by establishing which outcomes are plausible, which are improbable and which are so unlikely that they’ve never happened on Wall Street.
The S&P 500 isn’t exactly “quiet” right now, but it’s far from agitated. The market simply isn’t moving fast enough in either direction to justify a lot of fear or greed.
Maybe that means the VIX isn’t living up to its reputation for measuring ambient fear. I think it’s really just another byproduct of the Fed’s massive intervention in the bond market.
Free money encourages riskier strategies. Higher risk appetites embrace bigger bets. As a result, stocks swing more wildly.
But in general, the last 60 years of market history show that when stocks are moving at about this rate, the S&P 500 usually gains ground by the end of the month.
The gains aren’t huge, but every minute you’re in the market making about 3% a month is a whole lot better than every week you’re on the sidelines earning next to nothing. Compound the wins. They add up.
And when the market turns negative, don’t despair. Unless we see a massive volatility spike in the next few weeks, February is unlikely to turn into a complete rout for Wall Street.
We’re already three weeks into the month. It’s going to take the end of the world to knock stocks off their trend in the near term. I think the odds of that are low. Hang in there.
So where are we? As always, if you’re scared, retreat to the safety of dividend stocks. My Value Authority portfolio has plenty of ideas.
If you’re excited about the future, check out my IPO Edge. We’re holding up well here through the Robinhood ruckus. In fact, the active portfolio is up 65% as I write this, and that’s after we’ve cashed a lot of triple-digit-percentage wins.
That’s what I like to see. I’m talking about all of this on my Millionaire Maker radio show. Now there’s a podcast, available on both Spotify and Apple, as well, to keep you focused on opportunities to build real wealth while avoiding obvious threats.