Investors know how markets have been beaten the past few weeks. MASSIVE selling, much of it having to do with institutional margin calls due to too much leverage, has been the root cause.
But when selling grinds to a halt after big sell days, as we saw early last week, markets tend to begin to settle in the short term. Over time, this can be a setup for monstrous snapbacks, which we’ll discuss in this post.
If history is an accurate guide, markets could be nearing lows, meaning buyers in times like these will benefit over the long term. Thus, we are beginning to become bullish in what seems to be a contrarian way, given much of the news.
To set the table, when we say there was MASSIVE selling two weeks ago, we mean it. Our friends at MAPsignals, who track “big money” investors like institutions, pension funds, and so on, provide the stark outlook – there was 32 times more selling than buying:
We can't emphasize enough how extreme that level of is selling is. But what does this mean going forward?
From a historical perspective, we want to highlight a recent research report from Bespoke which explained that this is the ninth time in the history of the NASDAQ Composite Index that the index has fallen 25% or more (it’s now down about 27% since the November 2021 peak). Here are some interesting statistics (dating back to 1970) about those declines:
- Average days to drop 25%: 161
- Days to reach most current 25% drop: 171
- Average days to hit ultimate low: 209
But there is good news once the carnage finishes. Forward returns after huge drops are tremendous:
- One month: 1.9%
- Three months: 11.0%
- Six months: 20.4%
- 12 months: 33.5%
These last four bullet points are what begin to give us confidence in our contrarian bullish outlook.
For additional support, we turn to the trusty MAPsignals Big Money Index (BMI), which is a 25-day moving average of “big money” buy and sell activity. The BMI is getting closer to a deeply oversold reading (25%), as it sits at 27.1% as of this writing:
Time has shown that when the BMI has reached deeply oversold, it’s almost always an extremely bullish indicator for stocks. Going oversold is not common. There have been six oversold readings since 2014:
And since 1990, it’s only happened 20 times. That translates to about 5% of trading days over a nearly 32-year period.
Deeply oversold periods tend not to last long either. The average time it takes to reach the market trough after reaching oversold is only 9.5 trading days. After that, trends tend to turn upward.
Like the Bespoke data on the NASDAQ, MAPsignals data for the forward returns for S&P 500 are extremely bullish following oversold markets like this:
- One month: 2.8%
- Three months: 6.3%
- Six months: 11.3%
- 12 months: 16.0%
- 24 months: 29.2%
Again using an historical perspective, the soon to be rare oversold reading is bullish for stocks, on average. And from a timing standpoint, using BMI data since 1990, we can anticipate an expectation that the market could trough by June 1, 2022, if averages hold. But keep in mind we’re dealing with averages, so some leeway is required.
And while there's potentially some downward volatility in the short term, until sellers exhaust themselves, the good news is these readings indicate a grossly oversold environment. Most of this is a result of forced selling by institutional managers over the last week due to the leverage they have on portfolios resulting in margin calls.
As you can see in the chart below on the far right, sellers are getting closer to exhausting themselves. Soon there will be few, if any, sellers left.
This volatility has been unpleasant and painful. But remember, deals in stocks rarely get to this level.
Unfortunately, investing isn’t like buying a car, TV, or other material item. When those go on sale, we usually feel good. When stocks go on sale, it’s often accompanied by economic turmoil and other bad news. That stuff doesn’t feel good. But we should feel good buying great stocks at depressed prices because we’re most likely getting a great deal on our own future wealth.
Energy’s Outlook
Questions are swirling about whether it’s time to exit the energy and oil markets, which have been one of the only supportive sectors for portfolios this year. As we sit here today, the short answer is no.
Keep in mind the embargo on Russia for the global market can't easily be replaced or made up. Losing Russian oil and refined products puts the global market supply in a worse place than before. That’s reflected in the recent surge in crude prices:
Additionally, the emergence of the post-pandemic global economy is resulting in a significant rebound in energy demand. As Europe moves to a full embargo, it must access other global markets. But right now, there simply aren’t enough to replace Russian oil.
Remember that oil futures markets operate on three mechanisms:
- Readily available supply
- The outlook for future supply
- Sentiment
To put this equation in perspective, the U.S. and International Energy Agency are supplying the market with merely an extra 1-2 million barrels per day. Meanwhile, it’s estimated the world uses 88 million barrels of oil per day.
In this environment, the world economies are going to continue to need more fossil fuels as a bridge to not just satisfy current demand, but to avert a potential energy crisis that’s already unfolding in Europe. Our current supply-side dilemma is exacerbated by the fact that the Saudis, who are among only a handful of countries supplying the world with oil (see chart below), will not pick up the phone when the White House calls.
So from an investor perspective, we see a continued runway in energy as an inflation-friendly growth and income strategy. While crude is currently around $110 per barrel, refining companies are even more profitable as they are realizing profits as if the market prices were $250-350 per barrel. It’s reflected in the price at the pump:
Back in early 2020, the energy sector only represented a 2% weighting of the S&P 500. It’s risen to around 7-8% of the S&P 500 now. But historically, energy’s share of the S&P 500 is around 12%. That supports the thesis that energy’s bull market should continue to run in the short and intermediate terms.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.