Thursday, October 6, 2022
The S&P 500 hit a fresh year-to-date closing low of 3,584 on Friday September 30 before rallying almost 6% over the next 2 trading days, leading many investors to again wonder was that the bear market low? We first asked, “Was that the low?” in our June 2 Blog, and concluded that we were skeptical that the bottoming process was complete due to a lack of panic selling. After the lower low (with the S&P 500 at 3,667) on June 16 we revisited it in our blog “Was that the Bear Market Low (Part 2)?”. While we saw more market bottom signals at that time we had still not seen the levels of market capitulation or fear to believe that all potential sellers had been flushed out, concluding a new wave of selling was entirely possible. Today we re-examine some of the indicators we look at to see whether it is possible to say with any higher level of probability that the lows are in.
Below are some of the market data signals that we are monitoring and what they are currently telling us (with thanks to our friends from Strategas Research Partners for help with some of the trigger points).
- VIX – The Chicago Board of Options Exchange (CBOE) Volatility Index, commonly known as the VIX, has continued to be fairly subdued so far this bear market and has not hit extreme levels normally associated with market lows. Typically we have seen this indicator spike over 40 but the highest the VIX has been this bear market is 36 in early March, and on September 30 it was only around 32.
- VIX and S&P 500 declining significantly – When both the S&P 500 and the VIX decline simultaneously (by 1% and 5% respectively) it can signal that the last panic sellers are capitulating even as market fear, as measured by VIX, is subsiding. Directionally this did occur on 9/30 but it was a very modest decline in the VIX that accompanied the S&P 500 falling 1.5%. This signal is rare, occurring just 6 times in the last 10 years, but is one of the most accurate, catching the 2015, 2016 and 2020 lows to the day. Incidentally, the VIX and stocks both increasing significantly can be a signal of buyers getting ahead of themselves and this did occur on 9/12, which was the September high point with the S&P 500 at 4,110. Forward stock market returns from such an occurrence are negative on average for all short-term periods up to 3 months out.
- Put/call ratio – As measured by the CBOE composite put-call ratio 5-day moving average, this indicator tends to signal extreme selling pressure when it exceeds 1.2. This last hit the trigger back at the June lows but has subsided since then. On 9/30 it was at 1.07, still in the 90th percentile over the last 10 years but not in extreme territory.
- NYSE TRIN – This is also known as the arms index and measures the velocity of trading by looking at advancing/declining volumes and advancing/declining stocks. A TRIN score above 2 can be interpreted as a signal that the velocity of selling is at an extreme, while around 1 is considered neutral. The TRIN is the highest twitch trigger we monitor and it did trigger on 9/21, as well as earlier in September. On 9/30, however, the TRIN actually had a reading of 0.93 indicating that volume levels, at least, were actually leaning towards overbought. The bounce seen at the start of this week exhibited TRIN levels more akin to panic buying (scores under 0.5).
- Percent of S&P 500 greater than 200-day moving average improvement – The prior four signals were looking for flushed out data that was “so bad, it’s good,” but here what we look for here is an improvement in the technical price trends of equities from extremely low levels. We look for the percent of S&P 500 stocks above their 200-day moving average to fall to a historically low level (below 20%) and then rise back above 20%, signaling an improvement to the internal trends. This tends to occur after the other signals rather than simultaneously. After being under 20% for 7 trading days the percent of S&P 500 stocks above their 200-day moving rose to 22.5% following Tuesday’s rally, meeting our trigger criteria for the 3rd time this year. This exposes a weakness of this indicator that in a protracted drawdown with multiple bear market rallies, it can give false positive “all clear” signals.
With only two triggers hit during the past three months, none of the triggers hitting on 9/30, and all the readings at subdued levels there is nothing in this data, at least, to suggest Friday was the low. Typically bear market lows have seen all five triggers hit around the low, preferably with the percentage of S&P 500 above the 200-day moving average signaling last, and/or seen at least two, preferably three, triggers occur simultaneously at the low. There is no magic formula that says that these triggers have to occur for the market to bottom, but based on historical patterns it would be unusual for a lasting low to hold until the majority of sellers have been flushed out.
Some data that looks more positive for stocks in the short-to-intermediate term is that strong rallies like those that we saw over the first two days of this week have tended to precede periods with average returns almost double that of all other periods. Since 1950 there have been 52, sometimes overlapping, two-day periods with gains greater than 5% and the majority of these (41 out of 52) have occurred when the S&P 500 has been more than 10% below its all-time high, as it is now.
Overall we maintain our overweight to equities relative to bonds as we still see the overall risk proposition tilted more to the upside for investors able to tolerate increased volatility. Inflation has been slower to come down than we anticipated, but seasonal tailwinds, historically strong rebounds from shallow bear markets and midterm election year lows, and the likelihood that the end of the Fed rate hike cycle is only three to six months away remain supportive for positive domestic stock market returns.
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