On Monday, only 1% of stocks in the S&P 500 closed above their 50-day moving average. This was one of the most extreme oversold conditions in history.
In the past 15 years, the only other times when stocks were this oversold: July 2002, October/November 2008, and August 2011. The short-term results following these data points are mixed, with bounces over next 5-10 days, but lower levels on average looking ahead 3 months. One year later, though, the S&P 500 was positive 100% of the time with an average return of 23%.
2) In October/November 2008, there were a large number of extreme oversold readings. The S&P 500 would bounce roughly 24% and 27% after two of these readings, only to give back all of these gains. The ultimate low did not occur until March 2009.
3) In August 2011, there were a few extreme oversold readings. The S&P 500 would rally almost 12% after one of these before giving it right back. The ultimate low was reached in October 2011.
What will happen this time around?
The 5-10 day bounce is off to a good start, with the S&P 500 rallying 116 points on Wednesday, its largest point gain in history. The 4.96% advance was its largest percentage gain since March 23, 2009.
If we follow the 2002, 2008, and 2011 examples, an oversold bounce could very well continue in the coming weeks. But any such bounce is unlikely to be a straight up move to new highs. There are likely many sellers waiting up above, hoping for the chance to get back to even. This will create resistance, with wild swings back and forth likely. If there's one truism in markets, it's that volatility begets volatility.
For long-term investors, extreme oversold conditions are unquestionably a welcome sign. Stocks are on sale, valuations are cheaper, and prospective long-term returns have improved. For traders, the outlook is much less certain. While a near-term bounce is likely, it may not hold if history is a guide. At the very least, we should expect the next few months to be a choppy ride. Buckle up.
Comments 5
Many fundamental economic indicators are signaling a major buying opportunity. Especially in China and foreign markets. The relationship of global interest rates to equities is enormously positive for equities.
Historically on a market turn the emerging markets can significantly outperform. You could have a situation where with rising tbill rates you have the S&P up 20%, but China up 80%.
The U.S. corporate rate (BAA) is at 5.14%.
fred.stlouisfed.org/...
The Euro High Yield Index is at 4.70%.
fred.stlouisfed.org/...
Press the "max" button on the upper right of the chart and you will see the history of this last index. Notice how much higher rates were in 2008 and 2001.
Historically the earnings yield on equities is less than corporate bonds. Today, that is reversed for the S&P and foreign markets. That has been pushing markets higher throughout this bull market.
We are in a global financial system. The U.S. is no longer the totally dominant player. Is Europe going to tighten from these levels given BREXIT, France and Turkey?
Japan and China are engaging in economic stimulation. November retail sales in China are up 8.1%. That is not an economic collapse. China has massive new savings each year to allocate towards reorienting production. That is what they have been doing for the last 10 years. Their currency is still roughly 40% under what it would trade in a free market. That is an enormous competitive advantage.
First Trust AlphaDex China is an etf of 50 Chinese companies (FCA 23.03) trading on the Hong Kong Stock Exchange.
portfolios.morningstar.com/...
