Is The Stock Market’s Bottom In?

Over the past 2 weeks, our quantitative market studies have suggested that the U.S. stock market will probably retest its crash lows. That has happened.

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Here’s our latest update:

1. The stock market’s medium term risk:reward is bullish.
2. The short term outlook is no longer bearish. It is now a 50-50 bet. The stock market might fall a little more in the short term, or the bottom could already be in. Either way, trying to predict the exact bottom is a meaningless game. Nobody can consistently and accurately pick the exact bottom. Otherwise you would be a god.

When the market’s short term outlook is no better than a 50-50 bet, focus on the medium term.

The Medium Term is bullish

*Let’s analyze the stock market’s price action by quantifying technical analysis. For the sake of reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

High volatility, a bullish sign

The U.S. stock market’s volatility has been extremely high over the past 2 weeks. Using the intraday LOW, the S&P has fallen more than -2% in 3 out of the past 10 days.

This is uncommon, especially with the S&P so close to all time highs. Most periods of such high volatility occur AFTER the market has fallen more than 20-30%.

Here’s what happens next to the S&P 500 (historically) when it fell more than -2% in at least 3 of the past 10 days, while less than 15% below its 3 year high (e.g. right now).

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As you can see, this is a medium term bullish sign for the U.S. stock market, especially over the next 3-9 months.

This is a short term bullish sign for the stock market as well. 91% of the cases saw the S&P higher in 2 weeks, with the only “loss” case at a mere -0.17% decline.

The 200 day moving average

Yesterday was the first day in 2.5 years in which the S&P’s 200 day moving average fell.

In other words, the market’s trend has started to change for the first time in a long, long time.

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Is this a sign of “bearish trend reversal”?

No.

Here’s what happens next to the S&P when its 200 dma falls for the first time in at least 2 years.

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As you can see, this is not consistently bearish for the stock market on any time frame.

Gap down

The S&P gapped down yesterday.

The gap down was extremely large: more than -1% from the previous day’s close.

Here’s what happens next to the S&P 500 (historically) when it gapped down more than -1%. while within 10% of a 3 year high.

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As you can see, the stock market might experience some short term weakness, but this is rarely the start of a 40%+ bear market.

You know what’s more rare?

The fact that the S&P gapped down yesterday, and then rallied like crazy.

Yesterday, the S&P gapped down more than -1.5% and then closed 0.9% higher than the OPEN. From 1950 – present, this has only happened 2 other times:

1. February 6, 2018
2. April 4, 2018

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*Don’t pay too much attention to this. The sample size is small

More short term weakness?

VIX has made a divergence with the S&P 500. While the S&P has made a lower low, VIX also made a lower low (VIX moves in the opposite direction vs. the S&P 500).

This is normal for the bottom of the stock market.

When VIX falls -10% while the S&P falls at least -0.5%, and VIX remains elevated (>20)…

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…. the stock market might experience some more short term weakness over the next 1 week, but this is a bottoming pattern. Bottoms are a process.

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On average, these 6%+ corrections take 1-1.5 months to make a new all-time high.

Breadth is at an extreme

The U.S. stock market’s breadth is extremely low, which is a bullish sign for stocks in the next few months. Classic mean-reversion.

The Nasdaq’s McClellan Summation Index (a breadth indicator) is now below -750 for the first time in 3 months.

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From 1998 – present, this usually led to a bounce in the next 1-2 months.

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Likewise, the NYSE’s McClellan Summation Index is very low.

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When the NYSE McClellan Summation is as low as it is right now, the stock market almost always rises in the next few months.

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Conclusion

The stock market’s medium-term is decisively bullish, while the short-term is a 50-50 bet. Focus on risk reward and focus on the medium-long term.

Meanwhile, the Medium-Long Term Model remains bullish.