The crumbling of the stock market's fortitude in late trading on Wednesday may serve as an indication that the recent rebound is not to be trusted.
Over the nearly two weeks since U.S. stocks entered correction territory, many investors have started to wonder if the bull market is back on track, after a swift return to form clawed back much of what was lost.
But recovering from corrections is rarely that easy and smooth. In the last 90 minutes of trading on Wednesday, the Dow Jones industrial average lost nearly 500 points, suggesting that investor sentiment is still fragile and that it is still too early to call an end to the sell-off.
A correction in stock prices is almost always followed by a protracted phase of recovery that sees the initial lows revisited before the bull market resumes its long-term climb higher, said Jason Mann, chief investment officer of Toronto-based Edgehill Partners.
"There's nothing to suggest that the normal pattern of trying to find a durable bottom is broken here," Mr. Mann said. "The least likely thing now would be just to see the market rebound to new all-time highs."
Up until Wednesday afternoon, the market seemed poised to do just that. In early February, volatility made an emphatic return to a market that had grown accustomed to its absence. Runaway gains in U.S. equities and the steady succession of record highs gave way to an indiscriminate decline in stock prices around the world – the first substantial global sell-off in two years.
There was no event or single piece of news to blame. "It was just the market's realization that we are going through regime change, on Fed policy, on fiscal policy, on dollar policy and on trade policy," David Rosenberg, chief economist at Gluskin Sheff + Associates Inc., wrote in a newsletter
In just nine trading days, the S&P 500 index fell by more than 10 per cent – the informal threshold signifying a "correction."
The fear, at that point, was that the hour of reckoning market doomsayers have long predicted was upon us. Instead, the selling pressure vanished as quickly as it materialized and market bulls fully regained control.
"The rebound was no less dramatic than the sell-off," Mr. Mann said.
Over only six trading days, the S&P 500 index gained just shy of 6 per cent, quickly erasing most of the correction's damage and cueing a global rally that has seen Canadian, European and Asian stocks all make considerable gains.
And even after Wednesday's relapse, there are signs of complacency regaining its place in the attitudes of investors.
The CBOE Volatility index, the measure of expected near-term volatility in the S&P 500 also known as the VIX, has retreated back to its long-term average of about 20, having soared to more than 50 just two weeks ago.
Meanwhile, investors in general have rediscovered their faith in stocks with remarkable speed, according to a closely watched measure of sentiment. Last week, the AAII Investor Sentiment Survey reported that 48.5 per cent of respondents expected equity prices to be higher in six months. Just a week prior, that number was at 38.5 per cent.
"Back to maximum greed," Mr. Rosenberg wrote. "We are left, once again, with valuations stretched … and sentiment levels back to exuberance."
But the market is now much more prone to wild mood swings than it was prior to the correction.
U.S. indexes were trading comfortably in positive territory until midafternoon Wednesday, when the U.S. Federal Reserve released the minutes from its January meeting, seeming to reignite fears of rising interest rates and their potential effect on stocks. Rising long-term bond yields reinforced those concerns, as the yield on U.S. 10-year government bonds hit 2.95 per cent for the first time in four years.
"There is a lot of skittishness out there," said Ian Riach, senior vice-president at Franklin Templeton Investments Canada. "Volatility was so low, that sentiment now seems to change very quickly on any little bit of news. I think we're in for that kind of environment for a while."
Outside of bear markets and major market crashes, that is how corrective phases tend to unfold, wrote Bryce Coward, portfolio manager at Denver-based Knowledge Leaders Capital, in a recent analysis. Typically, corrections tend to last for six weeks to two months and feature both big rallies and retests of the original lows.
"Indeed, this classic give-and-take is how important bottoms are usually formed," Mr. Coward said.
If history is any guide, investors may want to brace themselves for many more days like Wednesday in the weeks ahead.