Stocks Ride The Kinga Ka. Did We Bottom On Friday?

An excerpt from our weekly market update from 03/07/2021...

The S&P 500 gained 0.81% this week with Friday's close at 3,841.94.

The price action this week was totally wild. While we're pleased with the S&P 500's ability to finish the week in the black, we can't say this week was all that enjoyable, to be frank. We prefer Ferris wheels, not roller coasters, and this week was one gigantic roller coaster! (click here)

The index began the week soaring to the upside, climbing 2.38% on Monday and closing back at 3,901.82. Things were feeling good yet again after Monday's close, as if last Friday's low at 3,789.54 was going to be a lasting bottom, but for the second consecutive week the price of the S&P 500 would then take a swift, violent turn for the worse.

The index traded all the way down to 3,723.34 on Thursday, a decline of -4.57% from Monday's close. Correlation doesn't always imply causation, but if it did then clearly the market didn't like what it heard from Jerome Powell on Thursday (click here).

After a strong jobs report before the bell on Friday the index traded back above the ~3,800 level, a gain of about 2% from Thursday's low, but that rally also met eager selling pressure, with the S&P 500 trading back down to the 3,730.19 level in the blink of an eye a mere two hours into Friday's session. Here there was a bit of despondence in the air. It was as if the S&P 500 couldn't move higher, as if the bleeding would never stop. After all, as of Friday's low all of the upside over the past two weeks had been met with a stomach punch; a sharp, swift, fast, violent price decline.

And that's when the S&P 500 traded beyond the limits of imagination, in a good way.

We spent the remainder of Friday's session absolutely roaring to the upside, as if the S&P 500's nightmare was over in the blink of an eye. The index turned what was headed toward a weekly decline of more than -2% into a weekly advance of nearly 1%! Despondence quickly turned to optimism, and the trillion-dollar question for the remainder of March is now whether or not the S&P 500 just bottomed for the month on Friday, March 5th at 3,723.34?

It's impossible to truly know the answer to this question, otherwise we'd make ourselves gazillionaires, but if you forced us to answer we'd shade in the circle next to "yes".

This week's low came in right next to January's low at ~3,694 and the one-day close below the 50-day simple moving average (50MA, blue line on the chart above), only to then regain the 50MA a day later, and reeks of a "bear trap" or "whipsaw".

Furthermore, this sort of reversal week has often marked lasting bottoms for the S&P 500. If we quantify this week's price action as a calendar week that trades down by -2% or more at some point during the week, yet finishes the week in positive territory and within -10% of our all-time high weekly close, we almost see nothing but lasting bottoms in the dataset. Each of the last six times this has occurred (spanning all the way back to 1998, so you know this is rare) the S&P 500 never looked back.

In other words, the S&P 500's low of this exact reversal week was the bottom for the next three months in all six samples.

The index closed higher by 3% or more three weeks later in all six instances, which would place a target for a weekly close at ~3,956 on March 26th.

The biggest driver of the S&P 500's recent swoon is the severe underperformance of the technology sector as defined by the Nasdaq Composite (COMPQ). This week was yet another example of the merits of a "barbell" approach toward equity allocations, with the energy sector gaining 10.09% on the week and most of the sectors within the S&P 500 finishing the week in the green, while COMPQ (the largest sector within the S&P 500) declined -2.06% for the week. COMPQ has now declined three weeks in a row and at Friday's low it was down -12.54% from its all-time high at 14,175.12 set on February 16th. That's a -12.54% decline in a mere 13 trading days.

At Friday's low, COMPQ was down -2.57% on the session and yet finished the day higher by 1.55%.

There's an old phrase about searching for market bottoms: "When the conditions are right, the tape will ignite". Well, something clearly ignited for COMPQ on Friday as the index reversed higher by 4.22%.

Another great phrase regarding market bottoms is "there's always a moving average somewhere", and look no further than the 100-day simple moving average for COMPQ's upside reversal on Friday (yellow circle). If you ever thought to yourself, "moving averages are useless", take a look at the chart below and consider reconsidering.

COMPQ's four-week pattern now resembles the "on/off" switch we've written about a lot lately. Four weeks ago COMPQ closed the week at a new all-time high weekly close. The switch was presumed to be "on". Here we are, three weeks later, and COMPQ has declined three weeks in a row, marking the pattern as an all-time high weekly close that's immediately followed by a three-week losing streak. It's as if someone turned the switch "off" four weeks ago.

Since 1970, we've seen this pattern for COMPQ twenty-five prior times and it has generally been a favorable sign over the near term.

COMPQ has closed higher three weeks later eight times in a row for average returns of 4.12%, and eighteen of the last twenty-one overall for average returns of 1.72%. There are a few landmines in the dataset, so while we hope Friday turned the switch back to "on", there's a chance it's still "off".

For the week ahead optimism is in the air, but a one-day reversal can't possibly hold all the cards. It's imperative there is upside follow-through over the week ahead.

The last two weeks have been defined by eager selling pressure into higher prices for the S&P 500. Friday's surge is no different than the surge to ~3,930 late February, or the surge to ~3,914 this past Monday, and both of those rallies were met with immense selling pressure that dragged the S&P 500 to lower lows on the daily chart.

We'll know this time is different if there isn't immense selling pressure this week. Our eyes are glued to the 3,914.50 and 3,723.34 levels, and we'd obviously like to see the S&P 500 trade above the former over the week ahead.

S&P 500 Primary Trend - Up

Despite recent tremors for the S&P 500, our work continues to label the primary trend as up or "bullish".

A hallmark of "bull markets" are "corrections" or "shakeouts", which are sharp, fast, violent price declines that serve to "shakeout" those market participants with weak hands (i.e., force these participants to exit their long positions). These downdrafts are almost always terrifying and they challenge the notion of the primary trend being up or "bullish". They serve to refresh fear and remind traders and investors that there is no free lunch - making money by trading or investing in stocks isn't always easy.

Capturing the equity market risk premium requires tolerance to these "corrections" and "shakeouts". As Charlie Bilello puts it, these downdrafts are the "price of admission". If you want or need to invest in equities to achieve your financial goals, then accepting the fact that -5%-10% of your portfolio can be gone in an instant is your ticket into the game. After all, all that's guaranteed in the world of investing is risk. Returns are only expected.

Happy Sunday!
Steve & Rick

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