Updated: Jul 17
The stock market has an absolutely disastrous start in 2022. NASDAQ is now in bear territory while S&P 500 and DJIA are in the correction territory. If the trend continues, this quarter is looking to be one of the worst Q1 performances for the US stock market in decades.
With the market being on a constant decline over the past few months, some of us are beginning to wonder if we are going to start to see a reversal soon. While nobody can accurately predict the bottom (and nobody should actually do so), let's explore a few indicators that I personally favoured to shed some light on the possibility of a rebound in the stock market.
Fear and Greed Index
I first wrote about this index in a post titled "Hello hello Mr Market! Are you okay?" in June 2020. If you are wondering what this index by CNN money is about, it's basically an index that is based on 7 indicators (eg. Junk bond demand, Market volatility etc) to determine how greedy/fearful investors are.
The latest reading on this Fear and Greed Index is now "Extreme Fear".
In fact, a score of 14 is extremely low. Just one month ago, we were looking at a score of 40.
If we look back at the past 3 years of data, the only time when we have such a low score on the Fear and Greed index was March 2020 (which we all know what happens then).
Traditionally, the market typically rebounds at least 10% within a year when such a low score was reached.
Smart Money Confidence
This is not usually as conventional an indicator as the Fear and Greed Index. it is a model created by SentimenTrader that aggregates indicators reflecting sentiment among institutional investors who are usually contrarian in nature and often trade against the general direction of the market. The model is called "Smart Money Confidence" as these institutional investors tend to have the largest long exposure near market bottoms and least exposure near peaks and hence their trading activities do provide good data/information.
From these indicators, a value is usually derived in a chart with upper and lower boundaries defined. When the value hits the boundary level, it's usually very clear signals to buy/sell.
If we look at the past decade, there are a few occasions when the Smart Money Confidence value reaches the upper boundary of 0.7. Those occasions are the March 2020 crash (due to COVID), China stock market sell-off in 2015 etc. For each of these occasions, the market went on a recovery every time the value hits the upper boundary. If history is to repeat, we might see something similar happening very soon too.
I have shared this indicator quite a few times in my blog with the most recent one in January. It's basically comparing two ETF values (RCD- Invesco S&P500 Equal Weight Consumer Discretionary ETF, RHS- Invesco S&P500 Equal Weight Consumer Consumer Staples ETF). Whenever the ratio of RCD/RHS drops against its 70-day moving average, a crash is imminent.
Since I blogged about the ratio of RCD/RHS dropping against its 70-day moving average on 20th January, the S&P 500 has dropped almost 7%.
Whenever the ratio of RCD/RHS starts recovering against its 70-day moving average, that's also usually a signal that the market is on an uptrend (as shown below) though it's usually a lagging indicator.
The latest graph now looks like this (when zoomed in).
While it might not be immediately obvious in the graph, the ratio of RCD/RHS is closer to the 70-day moving average now as compared to January. It might not tell us much since the ratio has not crossed above the 70-day moving average. Being a lagging indicator, it might not be the earliest indicator to signal a bottom (as compared to the two indicators above) and hence that could also be why it isn't the most conclusive indicator at this point of time.
Two out of the three indicators above have signalled that it could be possible a rebound (or at least a technical rebound) in the market is likely going to happen soon. But do bear in mind that the market could still be in a long term downtrend even if a rebound is to happen in the next few weeks. Determining the long term direction of the market is more dependent on the fundamentals. For instance, if the economy starts going into a recession and inflation still remains to be sky-high, we could be sure that returns from the stock market will be less than ideal for months or even years. I will revisit this topic on the fundamentals of the economy in a separate blog post.
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