Published: Jan 22, 2016 5:13 p.m.
They’ll be crystal clear only in hindsight.
After getting off to the worst start to a new calendar year in history, U.S. stocks on Friday finally posted the first winning week of 2016. So did stocks bottom or is this just a bounce within a bigger pullback that could yet turn into a full-blown bear market?
For the average, long-term investor, the best advice during times of market turmoil is to remain calm and stick to a long-term investing plan. Calling a bottom—or a top—is a challenge even for professional investors. With that in mind, here’s a look at what analysts and traders are watching:
It’s “abundantly clear” that Wednesday’s sharp selloff, which saw the S&P 500 SPX, +2.03% fall to its lowest intraday level since February 2014 at 1,812.29, marked a temporary low, said Adam Sarhan, chief executive of Sarhan Capital. But he suspects that despite the subsequent rebound, which may have substantially further to run, the bears are still in control of the market.
Rallies in bear markets tend to be quite strong, fueled by short covering and investors who rush in an effort to “buy the dip,” said Sarhan, who expects stocks to fall into a full-fledged bear market.
Getting to the ultimate bottom is going to take “a lot more time” and price deterioration, he said, noting that genuine bear markets tend to last from 18 to 36 months. In other words, don’t look for a bottom soon as the major indexes have yet to retreat 20% from their highs, which is the widely accepted definition of a bear market. A fall below 1,704.66 would put the S&P 500 in bear territory, while the Dow Jones Industrial Average DJIA, +1.33% would need to fall through 14,649.91.
The Russell 200 RUT, +2.34% is already in bear territory.
Matthew Tuttle, chief executive of Tuttle Tactical Management, is watching the 1,934 level for the S&P 500.
Matthew Tuttle, chief executive of Tuttle Tactical Management, is watching the 1,934 level for the S&P 500. A decisive push above that mark, which is the high from the Jan. 14 session, would persuade him that the selloff is over and that stocks are set for at least a near-term rise.
“If the S&P 500 breaks through…we think this is pretty much over and it’s kind of August, September all over again—a V-shaped correction and we move on,” Tuttle said. “We think the bull market ends this year, but if it gets above that level it doesn’t end just yet.”
There is more to it than surpassing a key chart-resistance level. A move above 1,934 would be confirmation of other signs of “total capitulation” that have already been observed, he said.
These include the move by Treasurys to new highs as investors flee for safety during the most intense portion of the stock market selloff, followed by a retreat in Treasurys, and rebound in yields, as stocks began to recover; and a surge in decliners as a percentage of total volume during the selloff.
Conversely, a fall back through the February 2014 low for the S&P would indicate a bear market is likely getting under way sooner rather than later, he said.
Oscillators and odd lots
Developed in 1969 by husband-and-wife team Sherman and Marian McClellan, the McClellan Oscillator is widely used by investors to help project when market trends might shift. The oscillator clocked in at negative 182.81 on Thursday — an indication that U.S. stocks are vastly oversold, and that a turnaround is nigh, according to Jeffrey Saut, chief investment officer at Raymond James. The oscillator is based on the daily breadth of the market: the difference between the number of stocks that closed higher and the number that closed lower. The oscillator takes this data, then uses complex statistical processes to enumerate trends.
Meanwhile, the number of odd-lot short bets placed on the New York Stock Exchange rose to a record high Wednesday, Saut said. Odd lots are orders of less than 100 shares. Because of their small size, such orders are typically seen as a proxy for how retail investors are trading. This can be a useful contrary indicator.
“Retail investors are usually wrong,” Saut said. The previous record for odd-lot short activity occurred on Aug. 24—the day stocks fell to their August lows. A short-term reversal began two days later.
As a result of the slump, valuations have fallen back. Analysts at the Institute for International Finance said forward price/earnings ratios relative to their 2005-2015 averages “suggest that not only the U.S., but most other mature equity markets are near or below longer-term values, while many [emerging market] equity markets are trading well below.” (See chart above.)
It’s a similar story for the banking industry group’s own measure of the household financial asset gap, which measures the deviation in the ratio of household financial assets to nominal gross domestic product from its long-term trend. The gap had been in overvalued territory since May 2014, a sign of a potential correction. The slump has largely closed the gap.
But the analysts aren’t ready to sound the all-clear, noting that “past episodes of correction in our asset gap metric suggest that prices could decline further, overshooting on the downside as happened in the aftermath of the dot-com and 2008-09 financial crises.”
Waiting for Buffet
For some analysts, the decline in valuations isn’t yet convincing.
“We feel like we have not hit the bottom yet as valuations are too high for value investors to start buying in earnest yet. Though it is very hard to know when the bottom hits in real time,” said Maris Ogg, president of Tower Bridge Advisors. “If you see a headline with Warren Buffett buying a company, that should be an indication that we hit the bottom. So far, no such news.”
Breaking the oil link
Collapsing oil prices have received much of the blame for the stock-market swoon.
Indeed, the correlation between oil futures and stocks has been extraordinarily high since mid-December. Stocks havemoved virtually in lockstep with crude, a phenomenon that is perplexed many market watchers who note that the historical relationship between the two assets has been weak.
See: Here’s how to know if oil prices have hit bottom.
A breakdown in the recent relationship, while not necessarily signaling a bottom, would be noteworthy.
“My expectation is that the strong correlation we are seeing at the moment will break down and we will go back to different financial markets trading on their own fundamentals again,” wrote Torsten Slok, chief international economist at Deutsche Bank, in a note.
It might already be happening in the currency markets, with the euro-U. S. dollar pair moving sideways since last summer as oil prices continued to fall, he observed. “But it may still take some time before this universal fear of lower oil prices begins to subside.”
Those that dare attempt to time the market need to take a quantitative approach, said Tuttle.
Without an arm’s-length, data-driven view, an investor is at the mercy of his emotions and perceptions. That is usually a recipe for trouble given the power of fear and greed to drive short-term decisions.
“There has to be some type of quantitative approach that gets you out [of the market] and there is got to be a quantitative approach that gets you in,” he said. “If not, you’re going to get out on the lows and you’re going to get in at the highs, and you’re not going to get anywhere.”