One Huge Exception to Our 'Melt Up' Advice
The market has reached a rare extreme… Sentiment is plunging… This chart says 'capitulation' is here… Beware the 'Markets in Turmoil' indicator… One huge exception to our 'Melt Up' advice… Bullish or bearish, be sure to join us on October 24...
In yesterday's Digest, we noted that the broad U.S. stock market had become extremely 'oversold'...
As of Thursday's close, a simple momentum indicator – known as the relative strength index ("RSI") – had dropped below 20 for the benchmark S&P 500. A reading that low suggests the market is wildly oversold.
This is a rare extreme. We've only seen four similar occurrences over the past 10 years: during the peak of the financial crisis in 2008... in 2011, as the markets panicked over the U.S. government's "fiscal cliff"... during the peak of the euro crisis in 2012... and during the last broad market correction in late 2015.
In 2008, 2011, and 2015, these extremes preceded only temporary rebounds before stocks made final bottoms several months later. In 2012, the market reversed higher almost immediately. But in each case, stocks rebounded sharply in the weeks or months that followed.
But it turns out the RSI alone doesn't fully illustrate just how extreme today's situation is...
According to data from Bespoke Investment Group, the S&P 500 closed yesterday at 3.77 standard deviations below its 50-day moving average ("DMA").
Now, don't worry if you're not great with math. All you really need to know is this is among the most "stretched" below its 50-DMA the S&P has ever been.
As you can see in the following chart, the S&P 500 has closed this far below its 50-DMA only 11 other times over the past 90 years. And again, in each case, the market rebounded sharply...
In other words, as we noted yesterday, decades of market history suggest we're at – or at least near – a short-term bottom in the market. And other indicators are sending similar messages as well...
Several measures of investor sentiment have reached bearish extremes...
For example, the Daily Sentiment Index ("DSI") is a reliable measure of sentiment among short-term traders. Readings of 85% or higher are considered extremely bullish and suggest a short-term market top is likely. Readings of 15% or less are considered extremely bearish, and suggest a short-term bottom is likely.
As of yesterday, the DSI for both the S&P 500 and the tech-heavy Nasdaq Composite Index had fallen to 10%, from 48% and 53% respectively at the start of the week.
Again, these bearish extremes are rare. And while they could drop even further in the near term, they suggest the odds of a short-term bottom are high.
Likewise, the "Fear and Greed Index" – a composite of seven different market indicators developed by CNNMoney – has dropped to just 8, representing "extreme fear." The index hasn't been around long. But similar levels of fear have occurred at or near every significant market bottom since 2010.
A measure of market 'breadth' called the NYSE Tick Index is also sending a positive message...
This index compares the number of stocks that are rising versus the number of stocks that are falling on the New York Stock Exchange. In simple terms, it's a measure of buying or selling strength.
As you can see in the following chart, the Tick Index plunged to -1,793 yesterday afternoon, indicating a massive flood of selling...
You might assume this is a bearish signal. But the chart shows that isn't typically the case. Instead, these big spikes lower represent the panicked selling, or "capitulation," that often occurs at a meaningful bottom. And yesterday's selling was stronger than any other day since the "Flash Crash" in early 2010.
Finally, we'll note that what may be the single most contrarian market signal on the planet has now been triggered as well...
Financial news network CNBC hosted a live "Markets in Turmoil" television special last night.
Of course, we're just having a little fun with the financial media's proclivity for drama. But it turns out that these specials have actually been a remarkably bullish signal over the past several years.
According to data from Charlie Bilello, director of research at Pension Partners, the network has hosted 24 of these specials since 2010, and the market has traded significantly higher over the next several months the vast majority of the time.
More specifically, the market was an average of 1.5% higher one week later 74% of the time... 1.5% higher one month later 65% of the time... and an impressive 7.3% higher three months later 100% of the time.
This "indicator" also has a perfect record of positive returns over six months, nine months, and 12 months. But considering that each of these samples occurred during the current bull market, those figures are a bit less impressive.
In short, virtually every indicator we follow is telling us not to get too bearish today...
We may not be at the bottom of this correction just yet, but the overwhelming majority of evidence suggests stocks are likely to rebound significantly in the weeks and months ahead.
Meanwhile, as Steve Sjuggerud explained yesterday, despite concerns to the contrary, his "Melt Up" thesis remains on track. Folks who panic and sell their stocks prematurely are likely to regret it.
For now, we remain cautiously bullish, and urge you to do the same.
However, this advice comes with one HUGE exception...
If this week's market volatility kept you up at night, it's a sign that something is terribly wrong with your portfolio.
Perhaps you've ignored Steve's advice for managing risk and gone "all in" on his Melt Up recommendations. Or maybe you're just a conservative investor who is unintentionally holding too much of your portfolio in equities.
Regardless, if you found yourself even a little panicked by this week's action, we urge you to reduce your risk immediately. What this means is an individual matter. At the very least, sell off some of your riskiest positions and raise some cash... Make sure you own a little physical gold... And if you have a substantial portion of your portfolio in stocks, consider "hedging" that long exposure with some select short sales or put options.
Why? Because as we often say, there are no guarantees in the markets.
History suggests the market is likely to bottom soon. But we can't rule out more downside before it finally does. And if the market falls another 10% from here – which would be well within the bounds of a "normal" correction – you'll be glad you took this advice.
One last thing...
Whether you were worried this week... or slept like a baby... we'd also encourage you to join us for our special event on October 24.
If you hope to successfully navigate the coming Melt Up – and the "Melt Down" that's sure to follow – we'd consider it downright mandatory.
That's because Steve and Porter will sit down with some of the biggest names in finance to discuss exactly what you need to know to safely profit from the final "innings" of this long bull market. And you'll even get one of Steve's top recommendations – a stock he says could soar 1,000% in the months ahead – for FREE, just for tuning in.
We guarantee this event will be unlike anything else you've ever seen from us before. Click here to learn more and reserve your spot now.
New 52-week highs (as of 10/11/18): none.
In today's mailbag, a reader wants to know why stocks have been falling. Which of life's great questions can we answer for you? Let us know at feedback@stansberryresearch.com.
"It would be real interesting for your organization to make a comment regarding all of your recommendations suffering fairly heavy loses the past 3 days. Especially with today's results. I would like to see your explanation when things are going South with the majority of your picks. It would be a breath of fresh air during turbulent times on what is going on in the market as we speak. Look forward to your response." – Paid-up subscriber Gary A.
Brill comment: If you're looking for a "reason" for this sell-off, there are plenty out there to choose from. Federal Reserve "tightening"... rising interest rates... the ongoing "trade war" with China... the upcoming midterm elections... the recent "blackout" period where U.S. companies must temporarily cease share buybacks ahead of earnings season... or maybe just the relatively rich valuations of most U.S. stocks today.
Unfortunately, there's no way to be certain. And most of the time there's no single, obvious reason. Trying to attribute "cause and effect" to the broad market's moves is a fool's errand.
What we do know is that no market moves in a straight line higher. And U.S. stocks had rallied nearly 14% since April with barely a dip along the way. That's nearly twice the market's long-term average annual return in just six months.
In other words, we were overdue for a pullback. And while you can't know what will trigger a correction in advance, you can be certain that a reason for it – or many reasons as is often the case – will eventually come along.
Regards,
Justin Brill
Baltimore, Maryland
October 12, 2018