Tuesday, April 15, 2008

Overnight and Daytime Market Regimes

The charts above decompose the S&P 500 Index (SPY) and 10-year Treasury rates ($TNX) into two components: changes that occur from close to open (overnight) and those that occur from open to close (day). For purposes of comparison, the charts are set to an arbitrary index value of 100 on 12/31/04. It doesn't take much analysis to see that the overnight and day markets behave quite differently. In fact, the correlation between overnight price changes and subsequent day changes is -.05 for SPY and .03 for $TNX. These, in essence, are separate markets.

The top chart illustrates how much of the stock market's bullish trend since 2005 has been a function of overnight price change. Indeed, a pure daytrader experienced none of the benefits of this bull run. To be sure, overnight exposure brings its risks, but closing positions at day's end also has greatly dampened reward.

Notice how, for the most part, interest rate changes have been much more pronounced during the day session compared with overnight: swings up and down tend to be larger. A good part of the trending behavior in rates has occurred during the day--at least until recently.

Which gets us to one of the most interesting aspects of this exercise. Until January of this year, much of the drop in stock prices since mid-2007 occurred during the day session. Similarly, much of the fall in interest rates (flight to quality) also occurred during the day. Since January, however, the day behavior of stocks has been relatively muted--as has been the day behavior of rates. Instead, we've seen pronounced overnight weakness in both stocks and rates since January.

This shift in regimes may be quite meaningful, reflecting a thematic shift in the markets. Much of the drop in shares and rates from mid-2007 through the January lows was a function of credit fears, whose epicenter has been in the U.S. Since January, however, U.S. stocks and rates have been responding increasingly to global recession fears, weakness in global share prices (across Asia most notably), and preopening economic and earnings reports related to recession.

It's interesting that the number of common stocks on the NYSE making fresh 52-week lows hit their highest level in January at exactly the time this overnight/day regime shifted. I believe that January low represents a pivotal point at which markets shifted their focus, such that overnight events--and the global economic picture--are now weighing more heavily on stocks.


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