Global market meltdown. That’s really the only way to describe the recent stock market plunge worldwide.
The selling began mid-last year in Europe, spread to emerging markets and most notably China a few months ago. Now the selling has caught up to U.S. stocks with a vengeance.
Just between last Thursday and Monday, the Dow Jones Industrials lost nearly 1,500 points! That’s extreme, but is it extreme enough to tell us the worst may be over and this could be a great buying opportunity?
History suggests it does.
First, numerous market breadth indicators are oversold in the extreme. Several have reached levels not seen in years, and only after much steeper corrections than this. Just take a look at the graph below …
This shows the percent of stocks listed on the NYSE trading above their 50-day moving average, a widely followed trend indicator. Typically, 50% or more of all stocks trade above this key level, signaling a healthy uptrend.
But notice how extreme low readings in this index line up almost perfectly with major stock market lows over the past five years.
In 2011 for example, when the S&P dropped nearly 20% in value, less than 10% of stocks were above their 50-day moving average. In other words, 90% of stocks were in downtrends.
This was such an extreme bearish reading that it screamed buy. That’s because stocks were so oversold there was nowhere to go but back up.
Sure enough, after bouncing around for a few months, the S&P soared 31.5% higher over the next six months!
Since then there have been several other extreme lows in this indicator (circled above), marking two major lows in 2012, several minor lows in 2013 with readings in the 30% range (not circled), and last year’s October low.
Every single time stocks rallied substantially higher.
But the current reading of just 7.5% beats them all. It’s the lowest since 2009! In other words, 92.5% of NYSE stocks have already sold off, and stocks are way overdue for a rebound, probably a big one.
Second, fear is so thick right now you can cut it with a knife. Just tune into CNBC for five minutes and you’ll see what I mean. I keep expecting Cramer to jump out of his studio window any day now.
The CBOE Volatility Index (VIX) is a more objective measure of stock market fear. It too is a contrary indicator. In the past, whenever VIX spiked sharply higher, it was almost always at, or very near, a stock market bottom.
This week’s extreme VIX print over 50 intraday was the highest reading in the last six years. Granted, it’s possible this signals a negative trend change for the market is underway. After all, VIX did ultimately spike even higher in 2008.
But much more often a VIX reading this high has been a reliable signal that stocks are oversold and to expect a rally in the weeks and months ahead.
Translation: if your time-frame as an investor is longer than a few weeks, this should prove to be a great buying opportunity.
In fact, my colleague Jon Markman recently shared some interesting stats from Sentimentrader.com that examined every VIX spike above 50 in the past 30 years.
After such extreme readings, the S&P went on to post a median gain of 7.2% just one month later, and stocks were up 97% of the time.
Three months later, stocks gained 11.8% and were up 98% of the time.
Going even further back, over the last half-century, there have been eight occasions when the S&P 500 plunged 8% or more over a three day period (which it did again Thursday-Monday).
Stocks subsequently bounced 99% of the time — enjoying a median gain of 6.2% over the next thirty days —and stocks were 22.9% higher one year later.
This doesn’t guarantee a bottom is in. Stocks could slip lower near term. But it does tell me panic selling — or worse, selling short — at this point is most likely the wrong move to make.
Based on an objective look at stock market moves in the past, the probabilities strongly suggest higher prices are ahead. Now’s the time to have your shopping list ready to scoop up some quality stocks on the cheap.