John Lynch Chief Investment Strategist, LPL Financial
The February 2018 market correction caught many investors off guard, but the longer-term trend remains higher. This year has provided more volatility than we’ve seen in recent years, with many wondering if the movement is a sign that the bull market is ending. Remember that when the market is finding its lowest point (the bottom), the process to get there can be quite frustrating and even confusing for investors. As a result, we acknowledge we are amidst the bottoming process, and we don’t think the bull market is ending, as longer-term technicals continue to look strong, along with sentiment flashing levels of worry seen at other previous major market lows.
Technicals Suggest a Bottom
Our methodology at LPL Research revolves around three basic tenants: fundamentals, valuations, and technicals. This week we will focus on technicals and show why we believe there may be an above-average chance that stocks have made their lows for 2018.
One major trendline we monitor to gauge the health of a bullish trend is the 200-day moving average. This is the average of the closing prices for the previous 200 trading days and is a nice way to assess longer-term trends. As Figure 1 shows, the S&P 500 Index has continued to find support near this important trendline.
The last time we saw market volatility similar to what we experienced in the first quarter of 2018 was during August 2015, and the S&P 500 didn’t fully bottom until February 2016. In other words, bottoms are a process, but we are seeing signs that this bottom could be near completion. Additionally, the S&P 500 recently tested the early February lows, but did so on lower volume. This appears to be perfectly healthy market behavior, as we tend to see tests of lows on lower volume.
Taking things a step further, we found that there have been 11 other times since 1991 that the S&P 500 tested recent lows (also known as a “double bottom”) on lower volume. We like to see lower volume on the test of lows, as it shows there isn’t the same level of extreme selling seen as the earlier bottom, thus the sellers have dried up. As Figure 2 shows, the various returns going out a full year are very bullish after this rare event—this may bode well for a continuation of the equity bull market.
Last, we like to see a “buying thrust” at major lows. A buying thrust is an uncommon signal that occurs when nearly all stocks go higher for multiple days. On April 3 and 4, the ratios of the number of S&P 500 stocks higher to lower were 10:1 and 7:1, respectively. This strength could be a good sign, but the fact that it also took place at the 200-day moving average and early February lows makes it even better. These buying thrusts, though rare, have a knack for flushing out any final sellers. As Figure 3 shows, a year after a buying thrust, the S&P 500 has gained more than 16% on average and risen 93% of the time.