Stocks Oversold At Extremes

Stocks Oversold - Another Down Day

The stock market had another weak trading session on Thursday. The S&P 500 fell 2.06% and the Russell 2000 fell 1.91%.

On the bright side, some of the hardest hit groups outperformed. The Nasdaq only fell 1.25%. EEM emerging markets ETF fell 1.01%.  Facebook stock rose 1.3%. I’m not saying it wasn’t a bad day. I’m just looking for positive action to help me figure out when the market will hit a floor.

Stocks Oversold - Time For A Bounce

Many indicators are signaling the stock market is oversold. As you can see from the chart below, the 14 day relative strength index of the S&P 500 is at 23.02. This is well into oversold territory which begins at 30.

It’s below the trough reached earlier this year. The S&P 500 is down 6.9% from its recent peak and earlier in the year it fell 10%. The RSI show the S&P 500 is the most oversold since August 2015. The market quickly recovered from that correction.

The S&P 500 is in a 6 day losing streak which is the longest since late 2016. It fell below its 200 day moving average. I don’t follow the 200 day moving average closely.

The fundamentals of the economy and earnings determine my intermediate term outlook. My point here is I don’t think the bull market is over because it fell through that level.

This has been a terrible week as the S&P 500 is down 5.5%. It would be its worst weekly performance since March if the week ended on Thursday.

This will be the first 3 week losing streak since June 2016. As you can see from the chart below, the CNN Fear and Greed index closed at 5 out of 100.  It signals there is extreme fear in the marketplace.

The chart shows this is a similar panic level to the correction this winter.

Stocks Oversold - Details Of The Market

The VIX was up 8.8% to 24.98 and gold was up 2.96% to $1,224.52. The best performer in the S&P 500 was the gold miner, Newmont Mining, which it increased 7.1%.

Oil fell 3% on Thursday and 2.4% on Wednesday because of this ‘risk off’ action which implies the global economy will weaken.

The dollar fell 0.45% to $95.03 which keeps it in the range it has been in for the past 4 months. The best sectors were communication services and materials as they fell 0.84% and 1.2%.

Both Twitter and Snap rallied after being crushed for the past few weeks. They increased 0.78% and 3.26%. The worst sectors were the financials and energy as they fell 2.93% and 3.09%.

The long bond has been a flight to safety recently, but not as much as you’d expect with such a large decline in stocks. The 10 year yield peaked at 3.23% and is now at 3.15%. I find it interesting that the stock market sold off after the 10 year yield increased.

If you think this is a rate driven selloff, you are saying the stock market had a delayed reaction. I don’t believe that. The 10 year yield fell 1 basis point and the 2 year yield rose 1 basis point to 2.85%.

The curve flattened as the difference between the 2 bond yields is only 30 basis points. Even after this correction in the S&P 500, the chance of at least 1 rate hike by December is 76.3%.

The futures market affects Fed policy. Right now, the correction in stocks hasn’t made investors second guess the rate hike in December.

Stocks Oversold - Fluor Stock Craters

We’ve seen PPG crash because of negative guidance and Fastenal decline because of the effect tariffs will have on its costs.

On Thursday, we had a third indicator the industrial economy is weakening. Fluor stock fell 17.24% because it issued weak interim results. The firm expects Q3 revenues to be $4.6 billion. It missed estimates for $4.95 billion. Fluor is a multinational engineering and construction company.

If PPG and Fluor are seeing weakness, global economic growth is likely decelerating. The American economy is outperforming the rest of the world. However, S&P 500 firms get most of their revenues overseas.

The Chinese economy is cratering. That doesn’t happen in a vacuum. The global economy is like a row of dominoes. When one large domino falls, the others follow.

Stocks Oversold - Positive & Negative Theses

In this section of the article, I will review the argument for buying stocks and the argument for selling them.

First, we have the chart below which shows that leading indicators have remained positive in this expansion. The bull market has continued. You don’t even need to look at the entirety of the leading indicators.

Just looking at the jobless claims gives you a similar success rate. No economic data catalyzed this recent decline in stocks. It’s fair to say the economy is in the same shape as it was two weeks ago.

The main negative news I have seen is from the 3 industrials I have reviewed.

The negative argument mainly focuses on valuations because the economy is doing well.

International growth is weakening, but the American consumer is in good shape as nominal wage growth is accelerating and inflation is decelerating.

When the economy starts to falter, stocks will have a lot of room to fall if you think they are overvalued. The chart below supports that narrative.

As you can see, 10 year compound annual equity returns minus commodity returns are near the peaks seen in the 1930s, 1960s, and 2000s.

Since the stock market bottomed in March 2009, these returns will look better in a few months.

Commodities are supposed to be doing well this year because economists expected inflation. However, the CRB commodities ETF is only up 1.43% year to date.

That’s even with the sharp rally in oil and the tariffs which have boosted metals prices. If this chart reverses in a couple years, stocks will underperform commodities for a while.



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1 Comment

  • Paul Scurko

    October 13, 2018

    Excellent insight.