Volatility is back…
That was the clear message last month. If you had any money in the markets, it felt like you had one reason to worry after another.
Oil prices peaked at more than $95 a barrel… Consumer-price inflation made its biggest monthly jump since January… And 10-year Treasury yields soared (which is a sign of falling demand).
All these headwinds have crushed the optimism folks started to feel earlier this year.
Stocks plunged almost 5% in a month. Now, investors expect the dip to continue. They’re going on the defensive… and bailing on riskier assets.
But right now, two signals are telling us this downturn may be shorter than most people expect… And stocks could even outperform from here, based on history.
Let me explain…
The market is flashing back to the punishing bear market of 2022.
We can see it by looking at CNN Business’ Fear & Greed Index. This gauge tracks seven different indicators – including volatility, momentum, and demand for “safe” investments, to name a few.
Then, it boils these metrics down into a rating from 1 to 100. A rating of 75 to 100 represents extreme greed… And a rating of 1 to 25 indicates extreme fear.
Last week, we got a major fear reading. The index fell to 18 on October 3.
It was a new one-year low. The last time this index was so beaten up was on October 14, 2022. But here’s the kicker…
That 2022 low happened two days after the market bottomed.
In other words, the last time investors were this fearful, it meant there was nobody left to sell. The Fear & Greed Index is giving us a potential buy signal.
And that’s not the only “green light” flashing right now.
You see, the S&P 500 Index just forged into “oversold” territory based on its relative strength index (“RSI”)…
The RSI tells us when an asset is running too hot in either direction. When prices rise too far, too fast, it pushes the RSI up past 70… an “overbought” signal. And when prices fall excessively, the RSI sinks below 30… an “oversold” signal. In either case, a reversal tends to follow.
The S&P 500 just hit oversold territory for the first time in a year. Take a look…
The index fell below an RSI of 30 last week, before reversing back out the next day. That tends to be positive for stocks. You can see that the last oversold signal happened last fall – not long before the 2022 low in the Fear & Green Index. And that signal kicked off the 2023 bull run.
Still, I wanted to know what this indicator means for stocks going forward. So I tested every time the S&P 500 has risen out of oversold territory going back to 1990.
Specifically, I highlighted every time the RSI dropped below 30 and then rose above it. And buying on this kind of move tended to lead to outperformance. Take a look…
The S&P 500 returns about 8% in an average year. But if you buy after stocks exit oversold status, you can beat that performance…
After breaking out of oversold dips, the index rose about 6% in three months… 8% in six months… and 13% in a typical year.
What’s more, after those instances, stocks were up a year later 79% of the time. So this signal has been reliably bullish over the past 33 years.
Investors are terrified today. The bad news may seem never-ending. But history suggests you shouldn’t join the panic.
The next leg up looks to be just around the corner… and all this negative sentiment should fuel the bull run to come.
Good investing,
Sean Michael Cummings
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Source: Daily Wealth