The month of August was just plain ugly for stocks with the S&P 500, Dow and Russell 2000 small-cap index all falling more than 6% last month. And the tech-heavy Nasdaq 100 Index tumbled nearly 7% lower in August.
At last week’s low, the S&P 500 was down 12.3% from its peak early this year and firmly in correction territory — a decline of 10% or more. It’s the steepest selloff for stocks since 2011.
The question on everyone’s mind is of course: where do we go from here?
Is the correction over, or is a bear market lurking — a decline of 20% plus — for stocks? While that’s a difficult question to answer, it helps to look at a few key indicators that give us a better perspective on the market decline.
First, it’s important to note that U.S. stocks are not the only victims of this selloff. To the contrary, the S&P is looking good compared with many international markets right now.
In fact, the MSCI All Country World Index, excluding U.S. stocks, sank 7.7% in August and is down 17% from its peak.
Meanwhile, the MSCI Emerging Market Index plunged nearly 9% last month alone, and is down 26.2% from its peak last year, already firmly in the grip of a bear market.
The breadth of the global market selloff is troubling because all markets are skidding lower, not just stocks. Bonds, both corporate and Treasury, international and domestic, are plunging too. And for commodity investors, it has been a nightmare with the CRB Raw Industrials commodity index down 29.6% from its peak back in 2011!
In other words, there has been nowhere to hide from the selling.
More troubling still, the sharp and sudden decline in August — with most of the damage done in just a few days — broke key long-term uptrends for most major indexes.
In fact, the S&P 500, Dow, Russell 2000 and Nasdaq 100 Index all closed below their respective 200-day moving average (MA) last month, and that’s a critical point.
When an individual stock, ETF or market index falls below this key technical support, it signals a loss of momentum and a bearish change in the long-term trend.
In the chart above, you can see monthly closing prices for the S&P 500 Index along with its 10-month MA of prices, which is roughly equivalent to the 200-day moving average (blue line).
As you can see, when stocks are trending higher above the 10-month MA, that’s been the time to stay long, but when prices close below this key trend line on a month-end basis, that’s been a good signal to stay on the sidelines.
Following this simple indicator alone would have kept you invested for the majority of the stock market’s uptrend from 2003 to 2007, and again since 2009, while side-stepping major bear market declines from 2000-02 and again from 2007-08.
Of course no indicator is infallible, and there have been a few false-positives. Most recently in 2010 and 2011 when you would have briefly been whipsawed out of stocks, before the uptrend resumed.
But on the whole, this indicator has served investors very well over the years.
The 10-month MA indicator works very well at signaling when to invest or stay away from other markets too, not just stocks. In fact, in his paper “A Quantitative Approach To Tactical Asset Allocation,” author and investor Meb Faber published a simple moving average approach to investing in multiple markets including: U.S. and international stocks, bonds, commodities and real estate using ETFs.
In a nutshell, the idea is that when the ETF is trending above the 10-month MA, you invest. But when the ETF closes below this key level, you take it as a signal to sell and go to cash.
In the table below, you’ll see where six major asset class ETFs ended the month of August in relation to their longer term 10-month moving averages.
All are below this key level and on a 10-month MA sell signal. Translation: There really is nowhere to run and nowhere to hide from this selloff, except in the relative safety of cash, until volatility subsides.
It’s impossible to know for sure how much more downside may be in store for stocks (bonds, commodities, etc.) but I’ll be watching closely to see if markets can rise above this key trend line by the end of this month.
Meanwhile, September is seasonally the worst month of the year in terms of stock market performance anyway, so holding some extra cash may not be a bad idea. Just remember, many stock market bottoms have been made in the month of October. Stay tuned!