Bottom Fishing

We’ve recently experienced a 10% market correction and that can feel unsettling. But keep this in mind: 10% corrections are normal, occurring about once every 12 to 18 months. In many ways, they’re healthy, helping to cool off excessive optimism and bring valuations back to more reasonable levels.

The big question is, how much deeper will this go? No one knows for sure — and that’s exactly why a well-diversified, disciplined investment approach matters. Staying properly allocated and rebalancing through market volatility helps position portfolios to take advantage of future recovery. Nevertheless, when markets bottom they often give hints when the bottom is in. Here are some signs to watch.

Four Steps to a Market Bottoming Process

On Tuesday, we hosted a webinar with Ed Clissold, Chief U.S. Strategist for Ned Davis Research (NDR), to discuss what investors should watch for during a market bottoming process. Based on historical trends and technical patterns, he outlined four key steps that markets typically follow:

    • Oversold – Selling becomes exhausted as the market declines.
    • Rally – The market attempts to rebound.
    • Retest – The rally fails to hold, and the market declines back toward recent lows.
    • Breadth Thrusts – A technical term that indicates broad participation in a rally, signaling strength and potential sustainability.

Step 1: Oversold

When a market, stock, or other asset class has fallen significantly and rapidly — becoming oversold — it often reaches a point where selling is overdone in the short term. This can trigger a bounce or reversal.

The chart below, from NDR, shows S&P 500 index on top and the NDR Trading Sentiment Composite (orange line). The sentiment indicators is currently well below 40 (circled area), which indicates extreme pessimism and a short term oversold condition.

Step 2: The Rally

The next step in the bottoming process is an attempted rally. As shown in the chart below, the S&P 500 Index has bounced off the blue horizontal line, which marks a point of prior support/resistance. Last Friday (March 14), the market staged a convincing rebound — with 15 stocks advancing for every declining stock. That level of participation, or breadth, indicates strong underlying demand. But that strength has not held, nor has the weakness returned. The market is moving sideways.

Step 3: The Retest

The point we are at now is where things get more interesting. Referring to the chart above, the expectation is that the market will go back and retest that recent low (the blue line). If the retest is successful, the market declines to — or slightly breaches — that blue line and then begins to rally again. This is a signal that buyers are stepping back in and that the near term low has been established.

Step 4: Breadth Thrusts

This final step helps us determine whether a rally off the retest is real or a head fake. A breadth thrust means that a large number of stocks are participating in the rally — across sectors, sizes, and styles, as happened on March 14. If that happens, it’s a strong signal that the bottoming process may be complete and a more durable uptrend could be underway.

What If the Market Breaks the Recent Low?

If that blue line is broken on the downside, then the four-step process starts all over again. This is more art than science.

Why might the market break support and continue declining? There are several possible reasons — most notably economic data is weakening, tariffs, and government spending cuts. The most recent selloff has been fueled by these concerns, all of which point toward the economy slowing. When this happens, investors begin to price in the possibility of a recession.

Our view right now is that there are no clear signs of a recession, but there are growing signs of an economic slowdown. Trying to predict recessions is incredibly difficult — and frankly, it’s a risky game. While it’s tempting to speculate, we avoid making drastic portfolio moves based on predictions. We recommend clients do the same.

Have a great week!

 

What We’re Reading

 

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

 

 

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By: Adam