By: Costas Bocelli — November 15, 2018
A garden variety correction…
That’s the consensus view among Wall Street strategists regarding the selloff that began in early October.
And they could be correct. But, call it what you will, it doesn't change the fact that, during times of market stress, like what we’re experiencing now, everything can look rotten to investors.
But the thing about market corrections is that they are normal.
Although I have yet to meet an individual investor who is excited to see the stock market sell off... corrective actions are necessary because they bring balance to the markets -- especially when investors become too complacent.
That’s exactly what had occurred earlier this year when the stock market became excessively overbought. What followed was one of the fastest corrections in 80 years -- a swift 10% decline.
Although the lows were made in less than two-weeks, the following ten weeks saw two retests of those lows before stocks found their footing and moved to new highs.
Now, the stock market is considered to be excessively oversold.
And although the major stock market averages such as the S&P 500 are trading above their recent from late-October lows , many of the internal breadth indicators remain in oversold territory.
One of those indicators tracks how many stocks within the NYSE Composite are trading above their respective 30-Week (or 150-day) simple moving average.
A couple of weeks ago we shared a graphic which showed that less than 20% of stocks were trading above this very important level.
Today the indicator is still very depressed, with just 22% of the stocks trading above their 150-day moving average.
(Click any image to enlarge)
Now here’s the good news…
Over the past decade, whenever we’d seen such excessively oversold conditions before, it turned out to be a fantastic buying opportunity.
And that's true despite the fact that it can be difficult to maintain a bullish stance in the midst of a correction. In fact, most investors get too bullish at the top and too bearish at the bottom.
That’s how Mr. Market games most investors.
Instead, you should embrace corrective actions because they often can provide lucrative opportunities to buy or accumulate high quality securities at a discount.
If you ask me if this is a garden variety correction, or something more nefarious my answer is: I’ll let price tell me.
Technically, the stock market is oversold as we mentioned. Does that mean that stocks can't push lower? Of course not. They can.
But aside from the market internals being oversold, a bullish pattern has emerged in the S&P 500. Chartists refer to it as an inverse head and shoulders.
And if the S&P 500 can break above a key level in the pattern called the neckline, it has a good track record of predicting reversals in downtrends.
Here’s a recent daily chart of the S&P 500…
As you can see, the inverse head and shoulder pattern has emerged since the correction began last month. The first down draft created the left shoulder. Then after a brief bounce, a lower low was made, creating the head.
And then in late-October to the post midterm elections, a relief rally has created the right shoulder.
Now, for the pattern to predict a bullish reversal, the S&P 500 has to hold these levels and trade above the neckline, which is highlighted by the green line on the chart.
That’s 2,815 in the index, or roughly 4% higher from the recent levels. It also happens to coincide with the 50-day moving average, another important metric.
Should we happen to see a break above the neckline, investors should take that as a confirmation of bullish strength. But the past week, since the Midterm election, has been anything but rosy for investors.
Plunging oil prices… Slowing global growth… Trade tensions and tariffs… Devastating fires in California…
All of these things have weighed on the markets.
But there is one thing that can provide a fertilizing boost to sentiment -- corporate profit growth.
Getting lost in the weeds is the fact the S&P 500 operating earnings for the third quarter are strong, up 25% from the same quarter a year ago. That’s the highest rate of profit growth in eight years!
Today after the close we’ll hear from NVIDIA Corp. (NVDA), the leading manufacturer of computer graphics processors and semiconductor chipsets. The company is expected to have generated $3.24 billion in sales for the third quarter, which is a 23% increase from the same quarter a year ago.
Earnings are expected to be $1.92 per share in the quarter which is a 31% increase from a year earlier.
While the company has been growing revenues and sales at a strong pace, shares of NVDA have taken a beating since the stock market correction began in early October.
Yet despite NVDA shares being down 30% since hitting an all-time high of $290 on October 1st, the stock is still up 200% since the November 2016 general election.
The options market is implying about a 10% move (or a $20 swing) in either direction following the earnings report in NVDA. A positive reaction could be the spark that sets off a bullish rally, and perhaps a test of the neckline in the inverse head and shoulders pattern.
But if it is a negative reaction, it could drag the S&P 500 and the other major stock market averages lower, and retest the late-October lows.
Now how’s that for garden variety?
See you after the Thanksgiving Day Holiday!