Stocks Bounce - Time To Buy Stocks
Sentiment on stocks has shifted so quickly the S&P 500 went from being overbought to oversold in a few trading days. The CNN Fear and Greed index bottomed at 6 out of 100 which signals extreme fear.
That doesnât mean stocks will increase over the next 12 months. It means stocks likely wonât crash further in the next month without a major fundamental catalyst.
Itâs important to remember that these corrections occur often and are usually buying opportunities. For most of this bull market, the moniker has been to buy the dip.
However, in 2017 and the summer of 2018 there werenât any dips. Investors got complacent. They paid the price either by getting too long stocks in late September or panicking after the 5% decline in early October.
A famous investment saying is money flows from impatient to patient investors. You canât let returns manipulate your emotions because that will cause you to make big mistakes.
Itâs usually a good time to sell when investors are euphoric. Personally, when I find myself bragging about returns, I know my portfolio is about to take a big hit.
As of October 11th, itâs time to buy U.S. stocks because investors are in a panic mode. As of October 10th, the NAAIM exposure index fell over 30 points to 52.86 which is the lowest level since May 2016.
Excessive pessimism in this index is below 30. The chart below shows the NDR daily trading sentiment composite. As you can see, it has fallen to 36.67 which is the lowest level since early April.
Since 1994, a reading below 41.4 is consistent with 31.79% annual gains. If you just look at the data since 2016, the returns are 28.67%. Near term returns are best when thereâs fear in the market.
In bear markets, fear is met with sharp rallies which disappear quickly. In bull markets, these selloffs are met with small rallies that build for weeks.
Stocks Bounce - President Trump Criticizes Fed
President Trump stated the Fed is âout of controlâ because monetary policy "is far too stringent."
He thinks the Fed has raised rates too quickly even though real rates are barely positive. The Fed just eliminated the wording that it is âaccommodativeâ in its statement which means the Fed thinks current policy is neutral.
It thinks the risk of an economic slowdown and heightened inflation are balanced. I think Fed policy is neutral. However, even neutral policy can slow growth in relation to the policy which existed previously in this expansion which was stimulative.
The Fed took away the punch bowl, but hasnât turned off the music and asked everyone to leave the party yet.
This entire discussion on monetary policy was catalyzed by the 5% correction in the S&P 500.
Itâs troublesome that anyone would look to the Fed to save the market from a normal correction because a 5% correction never used to be thought of an as issue. The Fed shouldnât rescue the market after a normal decline.
Stocks Bounce - Fed Acts After Stocks Fall 12.5%
As you can see from the chart below, the Fed has started to become more sensitive to stock corrections. From 1990 to 2006, the Fed remained hawkish during declines.
After corrections got bigger than 20%, the Fed turned down the hawkish rhetoric, but was rarely more dovish than hawkish. This is an interesting period to review because many blame the Fedâs dovish policy in the early 2000s for the housing bubble.
Rates were low when home buyers were taking out adjustable rate mortgages. Then rates increased, making housing unaffordable. The worst loans had teaser rates which started low and increased after the introductory period.
The orange line shows the Fedâs reactions to stock market declines since before the 2008 financial crisis. As you can see, the Fed becomes dovish after declines of only 12.5%.
The correction earlier in the year almost hit the point where the Fed usually intervenes. We are currently far away from another intervention.
Stocks need to fall much further. I donât pay attention to the left side of the chart because the financial crisis is the only period where stocks fell that much.
Keep in mind that Fed policy is manipulated by the futures market and treasury market. When near term yields crater, expect Fed members to make dovish statements. As of October 11th, the rate hike in December is still likely.
The final point I want to be clear about is the Fed didnât cause this decline in stocks, but it makes the market more vulnerable to corrections the more it hikes rates.
Thatâs why I said 2018 was going to be more volatile than 2017 and that 2019 will be more volatile than this year. Along with higher rates, the end of the effects from the fiscal stimulus and tariffs will make 2019 a tough year for U.S. stock investors.
Stocks Bounce - Large Bounces Common In October
Usually after the Nasdaq declines sharply in the first 6 days of October, it increases for the rest of the month. As you can see from the chart below, the Nasdaq was positive in the rest of the month 91.7% of the time. This was after it fell at least 1.21% in the first 6 days of October.
This is another example where history tells you to get bullish.
Stocks Bounce - Hurricane Michael Much Worse Than Expected
As I mentioned in a previous article, hurricane Michael formed so quickly that it wasnât fully anticipated by the market.
The new estimate by CoreLogic is that this storm caused $19 billion worth of damage. Thatâs a 42% increase from the previous estimate. The storm weakened to a tropical storm by the time it impacted South Carolina. However, the area was hit hard because it was still dealing with the impacts from hurricane Florence last month.
Mexico Beach, Florida had the most damage from this storm. I donât expect hurricane Michael to impact the labor market or GDP as much as Florence. But obviously it was a tragedy for the Florida panhandle.
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