I Know What the Market Did Last Summer (And So Should You)

Let’s talk about August last year. I have referenced it a few times in recent weeks so we may as well have a closer look at it.

I’m not talking about an analog, in that I don’t expect the market will look exactly like that but I do expect the general path will be similar. In August, the S&P 500 dropped from 4600 to around 4350 in the first three weeks. Then we didn’t turn upward from that oversold condition immediately, but rather we bounced and chopped and floundered. We ended that oversold rally with a good three-day surge into early September (blue box).

We didn’t turn south immediately after that rally though. We meandered around for a week or two and it wasn’t until mid-September that we gapped down and slid.

My point here is that corrections often take place in stages. They rarely take place in one fell swoop. There are several reasons for this, but consider some of these.

For the last five months the S&P did nothing but go up. We had that period from mid-December to mid-January that went sideways but aside from that every one-day rout was followed by another push upward. That ended in late March.

But isn’t it human nature to believe the trend in motion will continue? So the initial drop in early March led to a rebound, but notice the rebound did not make a higher high. Then we milled around, keeping the faith alive.

It wasn’t until last week we started to see folks get more concerned. Remember my comments about how folks discovered the Transports? Or how the perma bulls thought it was necessary to pen a missive about how corrections happen? With that in mind wouldn’t you say that the decline from 5250 to last week’s low around 4950 seems somewhat similar to the August retreat?

Now think about sentiment. We have seen a back off in sentiment. For example, the National Association of Active Investment Managers (NAAIM) folks have reduced their exposure from over 100 to the 60s. But if they are really scared, that will go lower. And typically that is what happens on the retreat after the initial oversold rally.

I am fond of saying you must think of bulls and bears as neighbors. For the last few months the bulls have had one heckuva party in their back yard. The bears slowly moseyed over to the fence, shared a cocktail, maybe two, and eventually they opened the gate and joined the bulls at their party.

They rarely jump the fence. It’s no different when the bears start to party. Right now I’d say a few bulls have moseyed to the fence. They should eventually have a drink or two and open the gate and join the bear party. And that’s when we’ll know no one expects the market to go back up to the highs. But that’s a process.

For now we’re still in that short-term oversold zone (although a down day or two would set us up for another rally, akin to August) but we are not yet at an intermediate-term oversold condition. That too takes time and that is why I expect after the short-term rally we should come down again.

Happy Passover to those who observe!

In Top Stocks I take a close look at the short-term and intermediate-term indicators, as well as charts and strategies for the GLD, Palo Alto Networks PANW, TLT and more.