Distaste for Stocks So High Even the Bears Are Starting to Run

You know things are bad in the stock market when Jeffrey Gundlach is closing out his shorts.

“The panic is palpable,” tweeted the billionaire money manager, saying it was the first time in years he didn’t have any bearish bets in his private portfolio. His words came as the S&P 500 was having another 5% plunge, its eighth consecutive daily swing of 4% or more en route to the fastest 30% drawdown.

At this point, such chaos isn’t completely unwelcome to some stock market bulls. The notion that capitulation or even panic is needed to drive the market to the lowest of lows is gaining traction among money managers hoping for signs of stabilization.

It’s a risky proposition, counting on the very thing that is driving stocks down to somehow arrest their descent. Spooked investors could obviously just keep selling. But for analysts looking for anything to premise a case for optimism on, it may be all they’ve got.

“The sheer movement of these markets on the downside, the fact that bond yields have already turned back up, the amount of panic that exists,” said Jim Paulsen, chief investment strategist for the Leuthold Group. “All of that is very reminiscent of getting to a bottom.”

In the latest sign, both traders and retail investors are finally running from exchange-traded funds tracking the S&P 500, illustrating pervasive demoralization throughout the market.

Someone — potentially a big institution — pulled almost $4 billion from Vanguard S&P 500 ETF on Tuesday, according to Eric Balchunas, an analyst at Bloomberg Intelligence. That was just a day after the market’s biggest crash since 1987 — amounting to the largest one-day outflow in the fund’s history, data compiled by Bloomberg showed. The $107.7 billion fund, ticker VOO, had previously seen 19 straight days of inflows.

It’s a signal the fastest bear market plunge in history has finally deterred mom-and-pop buyers that had piled in during the sell-off. But the outflows are also indication that the market is getting washed out and could be reaching the end of its drop. Traders yanked more than $6.5 billion from SPDR S&P 500 ETF Trust on Tuesday as well, and pulled $3.3 billion from BlackRock’s iShares Core S&P 500 ETF, or IVV, on Wednesday.

The S&P 500’s 30% drop is only its seventh since 1928 and the quickest by more than two weeks, according to Bespoke Investment Group. There are only two others instances where the speed of the decline was anywhere near as fast — 1929 and 1987.

“There’s just collapsed morale from investors, especially retail investors, that are focusing on their 401(k) or other funds they’re relying on in the future,” said Lance McGray, head of ETFs at Advisors Asset Management.

Hedge funds, who had been raising their bearish bets against stocks during the recent sell-offs, are starting to buy back shares to cover their positions. On Monday, the amount of net short covering hit the highest level since at least last December, according to prime brokerage data compiled by Morgan Stanley.

Read more: Battered Hedge Funds See No Relief as Darling Stocks Get Crushed

At RBC Capital Markets, Lori Calvasina for the second time in a week lowered her year-end and EPS forecasts for the S&P 500. She now sees the index ending 2020 at 2,750, with potential downside to 1,725 — that’s if it breaks below 2,300 and continues to trade along a similar path it took in September and October 2008, she said. Such a break would imply a 28% decrease from Wednesday’s close.

“Although we lower our target, we continue to believe that the bulk of the stock market impact from the coronavirus will be felt early in the year, with the bulk of the economic impact coming in the middle of the year, and a recovery trade taking hold later in the year,” Calvasina wrote in a note.

The current meltdown is striking a close resemblance to the path followed by the S&P during the financial crisis. At this point in October 2008 — while remaining volatile — stocks tried to find their footing over the next 10 trading sessions, according to DataTrek Research.

“Our 2008 Playbook says we could see U.S. stocks try to hold here. That’s what happened after the first violent downdraft in early October 2008,” DataTrek’s Co-founder Nicholas Colas wrote in a note. But overlaying 2008’s 32% drop onto today’s S&P prices would equate to 1,868. “That continues to be our worst-case scenario bottom,” he said.

The way Gina Martin Adams sees it, stocks are pricing in a worse-than-average recession. Tumbling oil prices raise the risk of an S&P profit recession, though the sector has less pull on earnings than in the past. But the 2020 crude plunge is greater than the average recession decline and would need to be joined by drops in orders and employment conditions to result in a profit recession, the Bloomberg Intelligence analyst wrote. Such a scenario could see EPS decrease by 14%, which would imply an S&P fair value of 2,665, she said.

While uncertainty about the profit outlook remains a drag, oversold levels and extreme breadth readings imply a bottoming process may be underway, she wrote in a note.

With the S&P in the 2,300 to 2,500 range, Jeff Mortimer at BNY Wealth Management sees investors fully discounting an earnings recession for the next 12 to 18 months.

“Down at these levels, you’re getting a bit more comfort in a scenario which doesn’t price in the worst news but prices in some pretty bad news and so you get people to take that chance,” said Mortimer, director of investment strategy at the firm. “When those buyers start to come out of the woodwork, that will be the bottom. But I think some of them are starting to dip their toe in the water here.”

— With assistance by Sarah Ponczek, Lu Wang, and Melissa Karsh

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