Reasons to Stay Positive During This Correction
Throughout client meetings this past quarter, the most common thread has been one of slight concern. This concern is justifiable considering all the noise out there in the 'negative' media. However, we have been steadfast in our position that the fundamental drivers of the current secular bull market are still in place. As uncomfortable as corrections can be, nothing during this correction has changed that view yet. Also there has been very little change to our Milestone Recession Risk™ Composite, giving us more confidence to stay the course. In addition, there have been a few important technical/sentiment indicators that have triggered buy signals for us. See our Q1 Market Commentary for more discussion on this, as well as a post we made right after the first sharp drop in the markets, here.
Today, we want to update you one of the most important indicators that has provided some assurance to us as markets moved into corrective territory. We have shared this indicator in the past, but here is a chart of the S&P 500 Cumulative Advance-Decline Line (AD Line) for the last twelve months. To refresh your memory, it is the AD Line is based on net advances, which is the number of advancing stocks less the number of declining stocks. Net advances are positive when advances exceed declines and negative when declines exceed advances. The AD Line is a cumulative measure of net advances. We view the AD Line as one of the most important indicators of breadth or health of the stock market. As you can see, during the corrective phase that began in late January, it has actually managed to hit three new all-time highs, which another one being registered this week. The most recent high could be the most important as it broke the upward trend line of the previous three highs, showing exceptional strength. You can see that when the S&P 500 failed to recover on more than one occasion, this breadth indicator showed much more strength. This is just one tool of many that we use in the background to help guide our decisions.
Source: Bespoke Investment Group, www.bespokepremium.com
As you can see in the below chart, this breadth indicator has prevailed at least in the short-term, as the S&P 500 Index has now broken a very clear triangle formation (usually considered a continuation pattern) to the upside. This is another piece of good news, and in conjunction with our positive fundamentals-based thesis, keeps us constructively positive in the intermediate and longer-term. We have manually put in the triangle formation so that you can visualize the breakout we have seen in the U.S. stock market this week. So although the market still has a ways to go to hit a fresh new high, the AD Line hopefully is guiding a path for higher stock market prices in the weeks and months to come.
Source: Thomson Reuters
We would like to finish off with one more chart to show the recent extreme oversold readings for the S&P 100 Index. At one point in April, over 60% of the stocks in the index reached oversold levels, which is the highest reading since February of 2016. The chart below shows the eight prior instances since 2003 where over 55% of the stocks in the S&P 100 Index moved into extreme oversold levels and then moved back below 55%. As you can clearly see, these have been excellent buy signals outside a recessionary period which we do not believe we are in or headed into. If you don't include the 2007 instance, the S&P 500 Index experienced a median gain of 24% to the next peak. In addition, in five of the seven prior instances not including the current one, this signal triggered after the intermediate-term low occurred, so this bodes well from a probability standpoint that the low is past us.
Source: Bloomberg, Canaccord Genuity