I nvestors all have different strategies of when to buy and sell. In situations where investors have a profit and markets turn for a negative trend, as is the case this year, the decision to sell or hold gets more challenging. Since the major market indices bottomed on March 23, 2020, the rally has been robust throughout 2021.
The chart below illustrates the major indices for this period, and as you can see, the SP 500 had the lowest cumulative return of only 89.08%, and the best performer was the SP 600 Small-Cap index turning in a terrific 108.9% period return.
Understandably after a strong two years, beginning January 1 of this year, all the major indices began a mild correction that appears to have bottomed on March 14. Nasdaq having the strongest rally since 2019, corrected the most this year, dropping 19.58% by March 14, and has also recovered faster than the other indices so far.
Today, investors continued their stock buying following the terrific March 14 week that was this years’ best weekly gain for the SP 500 and the best weekly gain since November 2020. During this year’s March 14th week, the SP 500 gained 6.2% while NASDAQ added 8.5%. The news that evidently prompts buying today is investors’ concern easing about the economic impact of the war on Ukraine and the Fed’s focus on slowing inflation.
The question is, what should investors do now and especially those that have been holding cash? Is this a buying opportunity or a “dead cat” bounce referenced when the markets have a short-lived bounce during a correction?
To answer this, we will focus on the technical aspects of the SP 500 and NASDAQ. Investors ideally want to buy at or as close to the bottom of a market correction. This is the type of year that annual performance reports may reflect single-digit returns for the indices when investors that buy at the bottom of the correction cycle can have substantially better returns than the year’s return of the indices. As an example, buying the NASDAQ Index Exchanged Traded Fund (ETF) on March 14 of this year could earn a 19% return if it just recovers back to where it started at the beginning of the year.
Regarding the SP 500, since 2018, the index experienced three corrections (a decline greater than 10% from the peak), as illustrated below.
The corrections cycles were completed as institutional investors reversed their selling and slowly, without any fanfare, started buying more equities than the amount they were selling. The change is rarely noted by the press and usually not the result of a string of robust rallies. The typical scenario is the slow reversing of more down days than up with more up days than down.
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The verification of the upward trend can be spotted early by watching the index 20 Day Moving Average (DMA) – the average closing price of the past 20 days. I like the 20 DMA because it smooths out even strong up days like March 2 when the Dow Jones Industrial Average (DJIA) closed up 1300 points. Claiming a one-day rally as the beginning of a new positive trend can be short-lived and may actually be the dead cat bounce referenced earlier. I am more interested in the change of a trend that is identifiable over several weeks vs. a single big day.
Notice in the chart below of the SP500 (purple line) that at the bottom of each of the three past corrections, the new rally was verified as the index recovered above its 20 DMA (blue line) and onto new highs. The rally is further verified by crossing its 200 DMA (orange line) and staying above both DMA to its next market peak.
The same is also true for the NASDAQ, the technology sector index. Notice in the chart below the NASDAQ index (brown line) the early crossing of its 20 DMA (blue line) followed by the crossing of its 200 DMA (orange line) to its next peak.
What Does This Mean to Me?
Both the SP500 and NASDAQ crossover points above their respective 20 DMAs occurred on Friday, March 25. Institutional investors have been steadily adding more equities than selling to their portfolios for the past 20 days, which continued today with another mildly strong day. Today was a typical bullish trading day, with the markets opening in the positive and then rallying throughout the day to close above their opening price. This is a positive sign as investors are buying into the day’s rally vs. selling later in the day for short-term profits, which sometimes indicates a lack of investor conviction the rally will continue.
For those interested in possibly investing at what may be the beginning of this next new rally, we would consider this week a good time to start adding cash back into stocks. Should the positive trend continue, the index will surpass its 50 DMA and eventually its 200 DMA. Many investors like to wait for the crossing of the 50 DMA as added confirmation of the established positive trend over the past 50 days. However, if you want to be early, the shorter-term 20 DMA will provide the quickest identification of a possible new positive trend. The downside of investing at the early beginning of a new uptrend is the market could reverse just as quickly as it started and why some investors like to wait for 50 days of a positive uptrend before investing.
Let us know if you have any questions about this Brief or your account. We maintain our overall positive view of the US economy and stock market and welcome the opportunity to assist you with your investing situation.