Correction Is Over
I think we all know that stock markets do not go straight up. Markets of all
types rarely do. Progress is usually made by taking three steps forward and one
back. We can all see this on a chart. However, a chart of what has happened in
the past does not convey the concern, the uncertainty and perhaps even the fear
that goes along with every decline, correction or bear market. At the lowest point earlier this month,
the S&P 500 was down close to 15% from the all-time high. After staging a recovery in the last
two weeks, most US market averages ended the first quarter with a decline close to 5%.
As the headline shows below, this is the first time stocks have had a quarterly decline in two years.
Therefore, I am sure you understand that what has happened so far this year is
as normal as can be. After a long rise, too much optimism builds up. A healthy
level of scepticism and doubt is what builds a firmer foundation for stocks
to advance. A correction eliminates this relative absence of fear. Of course, issues
or concerns always accompany a market decline because there are always
problems in our world. Corrections are going to occur from time to time
regardless of what is happening in current events. Often specific current events
are not the cause of a correction.
Most of the time the negative current events just happen to coincide with a
correction that was due to happen anyway. How can we be sure of this? We know
this because usually the markets recover well before the “world’s problems” are
solved.
Rather than trying to analyze how current events will resolve themselves, I
have found it is more useful to observe how investors are moving through the
cycle of emotions that occur during a market decline.
My co-author of Mind, Money & Markets, the late Janice Dorn, M.D., Ph.D.,
was a psychiatrist who studied the minds of investors. She prepared this chart of
the cycle of emotions that investors go through during major market advances and
declines. The feelings are similar during corrections, but not nearly as extreme as
what is shown below.
The situation is always a little different, but the reaction of investors is very
similar. Therefore, in my opinion, the best way to determine when a correction
ends is to observe where investors are in this cycle of emotions. How do we do
that? These are some of the factors I consider to see how investors are feeling.
Key reversal days are signs of capitulation and panic. (A key reversal day is
when stock market averages are in a steep downtrend earlier in the trading day but
end the day several percent higher than the low, usually ending the day with a
gain.) There were two key reversal days during this quarter. The key reversal days
happened on January 27th and February 23rd.
Markets often have a double bottom four to eight weeks apart before another
uptrend begins. This is a sign that stocks are now out of weak hands. The key
reversal days were only four weeks apart, but the uptrend did not begin until
March 14th, which was seven weeks after the initial low of January 27th. Please
see the year to date chart for the S&P 500 from WSJ below. Please also observe
that the S&P 500 hit a high of 4,631 on March 29th, which was higher than the
high of 4,589 on February 2nd and 4,587 on February 9th. Breaking above these
previous highs shows that there are once again more buyers than sellers.
Another indicator we can look at to determine a market low is to see when
many stocks have had a selling climax. A selling climax occurs when a stock
drops to a 52-week low but ends the week with a gain. The chart from Investors
Intelligence on the next page shows the number of US stocks that had a selling
climax two weeks ago was the highest since the market bottom after the Covid
sell-off in March 2020. Close to 1,100 stocks had selling climaxes. The selling
climaxes are the blue bars and the green line is the level of the S&P 500. Stock
market averages fell more than 30% in March 2020 so it is only natural that there
would be more stocks experiencing a selling climax then compared to this month.
The other factor we can look at is advisory sentiment from Investors
Intelligence. Market bottoms and buying opportunities usually occur when there
are more pessimists than optimists. Please see the chart on the next page.
You can see that the black line dropped below 0% recently for the first time
since December 2018 and March 2020. If you look at the green line, which
represents the level of the S&P 500, you will see that stocks bottomed and
started a new uptrend when sentiment improved near these levels. That is
happening now as stock prices have recovered close to two thirds of their losses
this year. The chorus of stock market experts becomes more optimistic as prices
rise, and more pessimistic as they fall. Looking at the 50-year history of this
sentiment suggests this is the time when the experts should be most optimistic
but that just does not and likely will not ever happen. Listening to the consensus
opinion may be useful for some things but it is not useful at all when it relates to
investing. This is why I spend little time reading market reports where experts
explain their logic. I look at research that shows how human reaction in the
markets compares to other similar points in history.
Another good indicator to look at is the long-term oscillator for the S&P 500
Index. When this oscillator declines to a low level and turns up, it indicates that
the worst-case scenario has already been factored into current prices. When that
happens, stocks cannot really go down anymore. Please see how this long-term
oscillator has bottomed and turned up on the next page. (Chart is from Refinitiv)
While US stock prices were down slightly for the quarter, this photo from
CNBC today shows that all 11 sectors of the S&P 500 were positive for the
month of March, another sign of a trend reversal across the board.
Ned Davis Research recently pointed out that only 10% of US stocks were
above their 10-day moving average at the lows. That reversed quickly to the point
that 90% of stocks were suddenly trading above their 10-day moving average. A
quick reversal like this has happened 36 times since 1982. The S&P 500 has been
higher by average of 14.23% 35 times out of 36 occasions. That is a 97.2%
success rate. The one loss was a loss of 5.9% in 2007 when US stocks were in a
long-term consolidation phase. US stocks are in a long-term growth phase now.
As of last week, 38% of investment experts were optimistic and 34% were
pessimistic. So, don’t expect to hear that many agree with my analysis. There will
continue to be plenty of debate and varying opinions until the verdict is clear a
few months from now. We can expect more experts to turn positive if stock prices
continue their recovery. In recent years, corporations have been buying back their
own shares in a major way after selloffs like this ended. This has enabled US
market averages to trade at record highs close to four months after the low was in
place. It will be interesting to see where the market averages will be four months
from the low, which will be July15th.
You can keep your eye on current events but they are not the driving forces
behind the selloff or the recovery. I have found the indicators discussed in the
previous pages to be most useful to determine the future trend for stock markets.
Time will tell how accurate they will be this time so.
In last week’s Update, I mentioned that Iraq invaded Kuwait in the middle of
the consolidation phase for commodities in 1990 and that history is repeating as
Russia is invading Kuwait in the middle of this consolidation phase for
commodities. I apologize for the error that many of you kindly brought to my
attention. Of course Russia has invaded the Ukraine in the middle of this
consolidation phase, not Kuwait. Let me remind you once again that it is amazing
how history often rhymes with what has happened in the past.
SAR Update
Our team was asked to help BC Ambulance with a serious ATV accident far in
the hinterland on Sunday. We were instructed to stand down and return to our
base after traveling about 40 minutes as the air ambulance was able to land close
the accident scene and evacuate the injured person. We are continuing to practice
and keep all of our vehicles, boats, ATVs and other equipment in top condition to
be ready for when it gets busier later on in the year.
Our team has also been training a number of new members that are now
starting to go on tasks with us. We are all helping them to “learn the ropes”
literally and figuratively. Please see a photo I took when we stopped to check out
an abandoned red ATV on the way back from the call Sunday night. Have a great
weekend my friend!
