We're hearing talk of a correction, but let's step back for a technical picture of the year's action to see why a sizable rally could be around the corner.
First, let's step back to see the entire year's performance. The Nasdaq and S&P 500 started 2023 slowly, but really gained some traction into the summer. For the year, these two indexes are up double-digits. During this summer, however, we have been plagued with very low volatility and not much movement on both sides of the market. Of course, that simply means there is little fear in buying stocks and up we go with the indexes.
Now, after a very solid five-month span, markets have taken a breather this month. Equities are down, but they may have reached a level where a substantial bounce may occur. Sentiment, according to the CNN Fear/Greed index and American Association of Individual Investor are still showing the bulls "think," they are in charge, but the internals of the market show otherwise. Look at the McClellan Oscillator, which is a daily reading of breadth. Breadth, remember, is a way to measure the number of stocks that are advancing vs. how many are declining.
The oscillator, thus indicates overbought/oversold conditions, or whether stocks are trading too far above or below what is believed to be their fair values. The oscillator has now reached a rare oversold condition.
It is from this point the odds favor a big rally. Why is that? When the oscillators hit certain levels (like now) there are just not enough issues to keep the indicator going lower. To turn the New York Stock Exchange's McClellan oscillator to zero, we would need 4,535 issues to go up. There are only 2,800 names on this listed exchange, so any positive is going to bring the oscillator back up from a very deep oversold reading.
Further, the oscillator when stretched, acts like a rubber band. Pull it back far enough, then release, it will snap back hard. In our experience, when a -250 (Wednesday night's reading) or a worse reading hits the NYSE oscillator, we often see a sharp bounce within about five days. Of course, it's not exact nor happens every time, but the setup is there. Looking at the oscillator graph, we see two prior times in 2023 when the indicator reached these low levels and a powerful rally ensued.
In addition, the S&P 500 has fallen through the 50-day moving average and is well below it for the first time in months. This very important moving average is the litmus test for big institutional players, who have been helping to push the markets higher since early spring. Will there be a failure here on this recent test? It's possible, as shorter term moving averages such as the 10-day or 20-day moving averages have turned lower. These faster moving averages are noisy, which means price will move sharply higher or lower around those trend lines, but when the trend is established and those moving averages tend to move in the direction of price, it becomes increasingly difficult to rally or penetrate.
It seems the markets are at a crossroads here, but certainly looking very likely a strong rally could happen soon. Markets don't go down everyday forever, nor do they go up everyday. We'll see if this become a buying opportunity. We recently added to some names in the Action Alerts PLUS portfolio when they dipped and will continue looking for more chances to add shares.
