In my last column on Aug. 28, I forecasted the beginning of a market correction based on the seasonally negative September-October period, the upcoming Presidential election, the lack of vaccine for the coronavirus and the overbought condition of the S&P 500 Index (73% of the index’s stocks were then trading above their 10-week moving averages).
As expected, the market downdraft began on September 3rd, when the S&P 500 Index (SPX) reached 3,588 and reversed. This past Monday, the SPX reached 3,229, a nearly 10% drop from the beginning of the month - almost reaching the official criteria for a correction. It gained about 1% on Tuesday.
The sell-off at the start of this week was fueled by the triple-witching expiry of the call and put options this past Friday and by continued worries about the economy. Monday’s action brought the SPX near its support level at 3,200; however, it is probably not the end of the decline, even given Tuesday’s partial recovery. Remember that we are not even half way through the September-October period.
In addition, the percentage of stocks above their 10-week Moving Average in New York is still at 63% and the Investors Intelligence statistics still show 55% bulls and only 18% bears among the newsletter writers. Therefore, we have no doubt that the correction will continue. However, Monday’s action will likely bring the bears out of semi-hibernation proclaiming that the SPX will decline to its March low of 2,192.
This is unlikely to occur. The most likely end to the decline will be near the usual one-third pull-back of the previous rise, which suggests a target of 3,125 for the SPX, 25,500 for the Dow Jones Industrial Average, 10,260 for the Nasdaq and 15,000 for the S&P/TSX Composite Index.
Looking at sectors, the most likely drivers of the decline will be the FAANG stocks for the SPX and the Nasdaq, and the financial stocks in Toronto. Historically and technically, Canadian banks are the first to start a new up-leg at the start of a bull market, stop rising at about mid-way through the bull, and they are the first to go down at the start of a bear market.
Which technical indicators will help us to recognize the end of the correction and the resumption of the bull market?
A market usually becomes “oversold” when (1) the number of declining stocks is 10 times larger than the number of advancing stocks, (2) when the downside volume outnumbers the upside volume by a ratio of 10-to-1, (3) when the number of stocks reaching new 52-week highs is less than 10, (4) when the SPX Volatility Index (VIX), which had been rising for numerous days, suddenly reverses and (5) when the percentage of SPX stocks above their 10-week moving average published by Investors Intelligence) declines below 15%.
Signals 1 through 4 are often featured in Globe Investor’s daily market updates and the fifth is published weekly on Wednesdays.
Ron Meisels is the president of Phases & Cycles Inc. (www.phases-cycles.com)
Editor’s note: An earlier version of this story incorrectly gave the target for the Nasdaq at 12,260.