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Here’s When You Should Buy Stocks Again

Stocks are selling off this week - but the data point to upside ahead. Here's where investors should go back in.

Well, the bull market was fun while it lasted. Or maybe it isn't over at all.

Stocks are in free fall this week as investors are spooked by the coronavirus.

The S&P 500 undefined kicked off the week Monday by gapping down 2.4%, the worst opening gap lower for the broad index since 1982. 

And it’s followed up with consistent selling, putting the broad market on track for its worst week since the financial crisis of 2008.

Is this finally the end of the rally that’s propelled stocks more than 80% higher on a total-return basis over the past four years? To figure that out, we’re turning to the data for a technical look.

First, as jarring as the recent correction may feel right now, it’s far from uncharted territory.

And the good news for investors is that historically, similar environments have led to positive returns for investors who held out.

Monday’s gap may have been pretty historic – the biggest in almost four decades – but it’s not that troubling.

Going back to 1970, the S&P 500 has opened 1% lower or worse in only 46 sessions. Monday was clearly one of them. 

But they haven’t been harbingers of bear markets – quite the contrary. On average, stocks have ended up 11.7% higher six months following a big gap down like the one we saw Monday.

Separately, the “worst week” narrative doesn’t mean a whole lot either.

Looking back to 1933, the S&P 500 (and its precursors) have seen 57 four-day selloffs as bad as or worse than the one we’re seeing now. 

And once again they tend to look a lot more like buying opportunities than precursors to market crashes.

On average, these week-long losing streaks lead to 16.3% gains a year later, with the stock market in positive territory about three-fourths of the time.

Here’s what the future performance has looked like historically following a nasty week like the one we’re in:

forward returns

There are a couple of important takeaways from the chart. The first is that the average forward performance for the S&P 500 is a clear, consistent uptrend. But the widening confidence intervals in the first 100 days or so post-correction do suggest that the initial reaction is somewhat more volatile.

In other words, it makes sense to wait for buying pressure to establish itself again before diving into stocks.

But more important, these are asymmetric outcomes. Good years are vastly more frequent and bigger than bad years. That makes betting on upside a lucrative move, on balance.

The return distribution paints a somewhat clearer picture:

return distribution

We’re in a “heads I win, tails I don’t lose that much” scenario – at least as of right now.

So, how should you trade it?

Screen Shot 2020-02-27 at 10.35.27 AM

In the intermediate term, we’re still holding the uptrend that’s defined by the S&P 500’s swing lows from before the sharp December selloff. 

Below that is the primary uptrend that’s been in play since the early days of the post-2008 rally.

Simply put, an optimal buying opportunity comes on a bounce off either of those.

We’re still about 7% away from a test of primary trendline support. The S&P could correct all the way down to that level (currently just below 2,800) without putting this bull market in jeopardy. 

(If that long-term buy zone gets materially violated, then the narrative changes.)

The technical picture and long-term trade statistics both support the idea that it makes sense to wait for the selling to play out before investors get back in to buy mode.

Look for a successful test of either trendline as a signal that it’s time to jump back in the water.

There aren’t any guarantees when it comes to the stock market. Nobody can be sure of what comes next. But the current atmosphere doesn’t rhyme with ones that have led to prolonged bearish environments for stocks. Not yet, anyway.