Bear Markets Can Stay Oversold for Weeks

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I can’t bear the news anymore – it’s overwhelmingly negative. A global coronavirus pandemic is ravaging our people. It’s infecting hundreds of thousands – and those are only the ones tested. It’s claiming thousands of lives. It looks set to claim many more. It’s halting our global economy, costing jobs, livelihoods, and stoking the flames of fear of ruin.

On top of all this, my family suffered the loss of a dear loved one to a heart attack on Thursday. I think the weight of the world’s ugly happenings weighed on her terribly. It’s tough to find anything positive right now.

But when the world looks this bleak, that’s precisely when to remain positive – to focus on life’s blessings, reflect on what we have, and look forth toward opportunity. This week, we will do just that. We will look toward what’s good and what light lies at the end of the tunnel.

As markets continue to plummet, we all naturally wonder when things will get better. The S&P 500 has fallen 31.9% from its Feb. 19 peak. Astonishing as it is, sentiment leans toward having further to fall. Let’s visit Mapsignals data to see what it says might be in store for us.

Let’s begin with a sector snapshot. The news, expectedly, is not good … or is it? All sectors are being punished with little regard for relative performance.

The above table tells us that the average selling of all 11 sectors is 190% of the universe. This means, for instance, that if a sector has 100 stocks in it, 190 signals were sold last week. That level of selling is typically unsustainable. I can’t point to any one sector and say, “That’s an area of safety.” It just doesn’t matter – if there is equity, it is being sold. Last week, we showed you sectors in terms of selling. Now let’s see buying.

Sector funds vs. big money buy index

Sector funds vs. big money buy index (continued)

While it may seem obvious that there is no buying going on, just look how the buying troughs line up with price troughs in each sector chart above. This further posits to unsustainable selling. These levels will be near zero come next week.

In a prior column, I predicted that my data would go oversold and perhaps coincide with a market trough on March 20. We actually went oversold on March 18. But what does it mean? What can we look forward to?

When we go oversold, it means that selling like this is unsustainable and that a bounce should follow. But when? To get an idea of past oversold periods in the market, I looked back through all my data going back to 1990. Excluding last week, there were 18 oversold periods. The following table sums up what happened:

When a market goes oversold, it can last one day or many. The table above includes the bear markets since 1990. This includes the internet bubble pop, tech-wreck, 9/11 (which led to many high-profile bankruptcies), the Global Financial Crisis, and several other turbulent patches.

The average duration of being oversold was 21 days (longest was 70 days). It took an average of 17 days to trough out the average drop of 8.6%. (This average was calculated using only periods of greater than one day.) We have already eclipsed the largest prior trough on record: -28.8% in October through December 2008, taking 45 days to get there. That was a dark time.

So, where’s the good? Forward returns of the S&P 500 after one, three, six, nine, and twelve months were positive on average. Here I summarize all four major indices’ forward returns

Does this mean it’s time to buy stocks? Before we answer that, here’s what’s happening: fund liquidations. I’ve seen numerous articles this past week about hedge funds getting roasted by this volatility. Big-name funds mentioned were Millennium, Citadel, Bridgewater, Point 72, and Capula. One article mentioned the basis trade being a pain point. One mentioned leveraged volatility products.

Either way you slice it, these five funds alone account for roughly $250 billion of assets under management, and it is common knowledge that they use leverage. If they levered four-to-one, that’s $1 trillion at work. And if they each operate with the assumption they won’t tolerate a -2% month at any given time, what happens when they lose 20% in a week?

Yuk happens: a frantic race for liquidity. If leverage is employed and trades reach their breaking point, margin calls come. A prime broker says: “You need to wire me $20 million by end of day or we liquidate your positions.” A mad scramble ensues selling anything liquid with positive profit and loss in the trade.

Add trillions of dollars of levered derivatives that blow past strike prices, and things get exacerbated – quickly. Fund meltdowns like the scenario above are happening. This CNBC article from Friday, March 20, details CME clearing firm Ronin Capital’s inability to meet a margin call.

I just briefly spoke about six hedge funds. There are roughly 10,000 in existence. And as of the fourth quarter of 2019, they had $3.2 trillion under management. The S&P 500 has a market cap of roughly $24.5 trillion. Levering hedge funds even 2x accounts for 25% of the S&P 500.

That’s how much of an effect funds can have on the market. This is a fear-induced, technically fueled sell-off seasoned with maximum pain. I believe that most of the liquidation phase of this rout is over, but we may have more in the pipeline.

However, it’s in these terrifying times of market turmoil that seasoned, brave investors like Warren Buffett begin to salivate. Equity values are getting juicy. Naturally, we are in for abysmal sales and earnings periods for at least a quarter – likely a few. But focusing on great businesses that can weather the storm with little debt and lots of cash is where value can be found.

The time horizon is best suited to be long when bargain hunting now. Looking at a horizon of years to come is when these stocks will be looked back at as dirt-cheap. It’s hard to see now with the global fear grip and dread of the coming recession, but now’s when the opportunity is high.

I can’t predict the market close tomorrow, but I can confidently say that, in several years’ time, it will look rosier than now. Prices will be higher. 

The data says now that we’re oversold – we have about 21 calendar days until oversold is over. We have about 17 calendar days to endure a trough. Those are averages, and this time is unprecedented. But the data has served me well in the past, and years from now, unfathomable as it may be, this dark time will be just another data point.

“Just when you think you’ve seen it all – see more.” – A.H. Scott

The Bottom Line

We (Mapsignals) are bullish on high-quality U.S. equities in the long term, and we see moments like these as areas to pick up great companies. 

Disclosure: The author holds no positions in any mentioned securities at the time of publication.

Source: Investopedia

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