The stock market and the economy now face significant challenges. So, it is no surprise that the majority of stocks are in a bear market, or at least a correction. When the market is in a steep sell-off like this, it is tough to know when it will bottom.
I know what you are thinking: “What bear market? The S&P 500 keeps hitting new highs.”
This is true. But it is only part of the story.
Under the hood, more than 70% of S&P 500 stocks were recently at least 10% below their recent highs, notes technical analyst Jason Goepfert, who founded SentimenTrader. Close to 60% of S&P 500 components were recently in a bear market, meaning a 20% or more drawdown, notes Lawrence McDonald of The Bear Traps Report.
In short, there is a stealth, internal correction. The S&P 500 is being propped up by a few strong names in AI.
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Looked at it a different way, the Invesco S&P 500 Equal Weight ETF (RSP) was recently 6.6% off its high, while the State Street SPDR S&P 500 ETF Trust (SPY) continues to hit new highs. Yes, a 6.6% decline is not a 10% correction. But keep in mind, the equal-weight ETF is being propped up by a handful of AI names, as well.
What’s going on?
It is possible that the internal correction is the market already pricing in at least some of the upcoming economic weakness that Jim Paulsen of Paulsen Perspectives on Substack has been predicting. While the economy continues to produce OK growth, he posits that high oil prices, high yields and the strong dollar, among other factors, are all putting downward pressure on growth.
Another problem for stocks is that earnings estimate revision momentum is slowing, notes Nick Raich at The Earnings Scout. The momentum slowed in the second quarter. It is slowing even more among the early Q3 reporters. When this momentum slows for two quarters in a row while the S&P 500 continues higher, it normally does not end well, says Raich. Typically, a correction or worse follows.
The tricky part now is that much of the market already has corrected, suggesting that at least part of the estimate revisions momentum slowdown and the potential economic slowdown is already getting priced in.
On the other hand, investors are complacent. Complacent investors are vulnerable to “surprise” in response to any stock weakness among the tech leaders. Selling can compound selling when investors are complacent. The Investors Intelligence Bull/Bear ratio recently came in at 3.62. This signals complacency, which makes the market vulnerable to selling. Investors are complacent because they are paying more attention to the S&P 500 hitting new highs, rather than the internal correction that is playing out.
Here’s the bottom line for me. Despite these risks (potential economic slowdown per Paulsen, revisions momentum slowdown a la Raich, investor complacency), starting to average down in a 10%-20% decline has been a successful tactic in the past, even if it inevitably means being early. Just plan purchases in several phases. Also note that October 12 on average tends to be the low for the year, and it typically marks the end of the traditional September-October market weakness phase.
Insiders are generally now under broad trading lockdowns ahead of earnings season. But executives and directors at several companies have recently made bullish purchases nevertheless. For detailed analysis of their companies and the catalysts that might make their stocks go up, consider subscribing to Cabot Insider Edge.
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