Photo by Nicholas Cappello on Unsplash
 

Is it Time to Buy Stocks? 

The stock market tends to bottom when there’s peak uncertainty and pessimism. As it stands, analysts are skeptical, big banks are bearish, and market indicators say there’s uncertainty. With this in mind, is the stock market close to a bottom, and is it time to buy stocks?

Here’s some perspective.

Analysts have been slashing their earnings estimates.

At the end of the second quarter, analysts said they were expecting S&P 500 companies to report earnings growth of 9.8% for the third quarter. Now, analysts expect S&P 500 companies to have an earnings growth rate of 3.5% in the third quarter. If this ends up being the final figure, it would be the lowest earnings growth rate for S&P 500 companies since the third quarter of 2020. (Source: “Earnings Insights,” FactSet Research Systems Inc., September 16, 2022.)

Moreover, big banks are saying the stock market could keep falling.

Bank of America‘s (NYSE: BAC) Michael Hartnett is advising clients to “nibble” when the S&P 500 gets to 3,600, “bite” when it gets to 3,300, and “gorge” when it gets to 3,000. At the time of this writing, the S&P 500 sits at 3,880. Hartnett’s target of 3,000 would mean a decline of 22% from the current level. Market gurus at Morgan Stanley (NYSE: MS), JPMorgan Chase & Co (NYSE: JPM), Goldman Sachs Group Inc (NYSE: GS), Citigroup Inc (NYSE: C), and other large banks have come out with similar pessimistic statements about the stock market.

Thomas Peterffy, the chairman and founder of Interactive Brokers, says the brokerage’s customers have been hedging their positions for months: “[T]hey have taken short positions in futures or have written call options against their stockholdings.” Peterffy expects the stock market to bottom when the S&P 500 reaches 3,300. (Source: here,  MarketWatch, September 19, 2022.)

Active money managers aren’t too keen on stocks these days, either.

Take a look at the chart below; it plots the National Association of Active Investment Managers (NAAIM) Exposure Index. It essentially shows how active money managers have allocated their investment portfolios. A reading of 100 would mean their entire portfolio consists of stocks.

Since the beginning of this year, active money managers have really trimmed their stock holdings. At the moment, their portfolios are about 34% stocks, versus almost 100% earlier this year.

Chart courtesy of StockCharts.com
 

How Low Could the Stock Market Go?

With all this in mind, one could still be wondering if it’s time to buy stocks.

There’s more to the equation that needs to be understood. While pessimism and bearishness are certainly signs that a stock market bottom could be nearing, you also need to see the economic data take a turn for the worse. At the moment, the economic data looks relatively stable, even with the decline in the economic growth rate in the first two quarters of this year. So, the bottom isn’t close yet.

Using the S&P 500 as a measure of the stock market and using technical analysis, the market could go down a lot more.

The S&P 500 is currently finding a lot of resistance around its 50-week moving average. The index broke below this moving average in early 2022 and has tested that level twice so far but failed to bounce above it. As this happened, momentum indicators turned bearish and trading volume increased, suggesting that there are many sellers out there.

Chart courtesy of StockCharts.com

The next support level for the S&P 500 could be the 200-week moving average, which is around 3,586, or roughly 7.4% lower. This moving average has acted as a support level for the S&P 500 since 2016. In 2020, the index dropped below that level but recovered very quickly.

If the S&P 500 has a hard time holding at its 200-week moving average, the next support level isn’t until around 3,350 to 3,380. Below that range, the next support level is around 3,000. If the S&P 500 breaks below 3,000, it could trigger selling until it falls to the 2,175 level. Assuming the S&P 500 goes to 2,175, it would mean a drop of more than 40% from where it currently stands.

To those thinking the stock market bottom is already in place, be careful and don’t be too quick to judge.

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