Technical Evidence Building That The Stock Market Bottom Is Already In

Summary:

  • In my prior post, “When Is the Buying Opportunity,” I argued that when the S&P 500 Index falls by 30% or more, it almost always results in a generational buying opportunity within 3–6 months
  • The S&P 500 Index hit a low of 2,290 soon after I posted, and is back over 2,700 today
  • In this post, I identify several technical “tells” which indicate that the market may have already bottomed out: 1) the NYSE High-Low Index, 2) the VIX, and 3) rampant insider buying
  • You may want to fade this bear market rally, which is driven by a lot of short covering, and that’s fine … but these indicators suggest that market is NOT likely to retest the lows set in early March, absent a major surprise on the fundamentals …
  • … also, I’m ignoring for now fundamental indicators (how long it will really take to have widespread, reliable serology tests in the US and Europe; corporate earnings; the state of credit markets / muni bonds, and mortgage REITS in particular; and where oil and gas prices settle out).

“A ‘tell’ is a change in a player’s behaviour or demeanour that gives away information regarding that player’s assessment of his hand. A player can gain a significant advantage if he observes and understands the meaning of a particular player’s tell.”

- PokerDictionary.com

A good stock market is like a world-class poker player: she will give you signals to what cards she’s holding, but those tells often change slightly. They will come at you quickly, in different shapes and sizes. At times, she will sucker you into making a mistake because you want to believe — and sometimes you’ll look back on your fold / raise decisions with disbelief. But if you’re watching carefully, you’ll improve your odds of winning.

I’ve been watching this market carefully, and I’ll caveat that I want to believe, because I fundamentally believe in the U.S. economy, the resiliency of its financial system, and the resourcefulness of its people. I think the fundamentals of the U.S. economy in recent years have been in good shape, and that the broader public markets will come out of this relatively short down period poised to grow significantly into the future.

With that out of the way, I think that I see three strong technical tells that the bottom is already in (probably). This is not an assessment of the fundamentals of the US economy, of corporate earnings, or how long it will take to normalize commercial activity in the US — those are topics for a different day. These are just some technical indicators that tell me that this market is unlikely to test the March lows, absent some major surprise on the fundamentals front.

First, there is the New High-Low Indicator. This index measures the ratio of stocks in the index that are hitting new highs versus achieving new lows. As broad market indicators form bottoms, the ratio of “new highs” to “new lows” increases. In the last recession, this indicator bottomed out in October 2008, as the world was panicking and sellers were selling everything indiscriminately.

In March 2009, the S&P 500 bottomed out. But the “NYSE High-Low Index” (calclated by simply subtracting new lows from new highs, over a 52-week period) had actually hit its nadir several months before back in October 2008. And as each new market low after October, the NYSE High-Low Index had refused to make a new bottom. This may seem counter intuitive but the reason this happened is that the broader S&P 500 is cap-weighted, and stocks with the highest weights tend to get sold during the latest part of the bear market. Additionally, fund managers often rotate from the heavy index weights to stocks that have much higher rebound potential.

Chart 1: S&P 500 Index vs NYSE High-Low Index, 2007–2010

Source: Yahoo Finance; StockCharts.com. $NYHL is an indicator of market breadth that is calculated at the end of each day by taking the number of stocks making New 52-week Highs on the NYSE and subtracting the number of stocks making New 52-week Lows.

This worked very similarly in some other bear markets. In 2002, the stock market low started forming in October, and then ultimately fully bottomed out in March 2003. But the high-low index was already signaling the next leg up; it bottomed in July 2002, refused to make successive new lows as the bottom firmed, and came out close to neutral in early 2003, which was the signal to buy.

Chart 2: S&P 500 Closing Price, June 2002 — June 2003

Chart 2a: Daily snapshot of NYSE High-Low Index, June ’02-June ’03

Source: Yahoo Finance; StockCharts.com. $NYHL is an indicator of market breadth that is calculated at the end of each day by taking the number of stocks making New 52-week Highs on the NYSE and subtracting the number of stocks making New 52-week Lows.

Now sometimes, Miss Market (like every good poker player) throws you a fake tell, and suckers you in. For example, in December 2018, this high-low indicator bottomed alongside stocks on December 24th. Had you played your hunch then, you would have missed out on a 5–10% January rally. But that had a lot to do with the thin holiday volumes, and ultimately the high-low index did tell you … to within a few weeks… of where the bottom sat.

So what are we seeing right now?

The NYSE high-low indicator bottomed on March 11, while stocks bottomed on March 23. In recent days, on April 7th and 8th … and unbelievably for some investors … this indicator has come right back to what I call “neutral,” i.e. the same numbers of new lows as new highs.

Chart 3: NYSE High-Low Index since January, 2020

Source: Yahoo Finance; StockCharts.com. $NYHL is an indicator of market breadth that is calculated at the end of each day by taking the number of stocks making New 52-week Highs on the NYSE and subtracting the number of stocks making New 52-week Lows.

While I think it’s possible that we see another market low going forward (with another, higher low for the NYSE High-Low index) this suggests to me that market breadth will provide support for the market below current levels.

Second, another strong tell is that insiders are rampantly optimistic, and have been buying in recent weeks. In the U.S., the ratio of companies with insider buying compared to insider selling is at 1.75 for March, its highest level since March of 2009, according to Washington Service, a provider of insider-trading and data analytics.

2IQ Research publishes some great stats on insider buying, and this chart shows that this isn’t just an American phenomenon. Look at how optimistic corporate insiders were last month, particularly in Italy and Spain, where the headlines were the most grim:

Chart 3: Insider Buying, in Different Countries

So either insiders have collectively lost their minds, and can’t tell the light at the end of the tunnel from a oncoming train, or else they believe that the market isn’t giving them enough credit for how they will manage the coming recession.

Finally, I talked about the VIX (CBOE volatility index) the last time. It peaked at just over 82 on Monday, March 16 … a level that exceeded the worst of the prior financial crisis (on November 8, 2008, the VIX hit 80.74). Peaks in the volatility index (which measures the implied volatility of the S&P 500 Index) typically coincides with market bottoms. In November 2008, the peak of the VIX didn’t exactly signal a market bottom … there was subsequent pain, and it took another four months to formally hit the nadir … but it was pretty darn close, and it did mark the beginning of the buying opportunity.

In 2001/2002, the VIX peaked with its 10-day moving average peaking at 38.5 in October 2002. At that time, the market was in the middle of forming its bottom: between October 2002 and March 2003, the market basically traded flat before beginning its next long bull run.

This time around, the VIX has fallen to about 44 … still elevated but with three solid weeks of reductions from its record.

Former C-suite at PayPal, Sonos, eBay. Now general partner & founder at Practical VC, a secondary venture capital fund.

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