Posted by Adam Turnquist, CMT, VP Chief Technical Strategist
Wednesday, October 18, 2023
Key Takeaways:
- The S&P 500 has made an impressive recovery after finding support near 4,200, a level that traces back to an uptrend off the October 2022 lows and the rising 200-day moving average (dma).
- Momentum is improving off deeply oversold levels. The S&P 500’s Bullish Percent Index (BPI) recently fell below 30%. Historically, oversold BPI readings of this magnitude have represented buying opportunities. The broader market has posted respective average one-, three-, and six-month returns of 2.7%, 6.1%, and 8.8% after the BPI crosses below 30%.
- Of course, the current recovery doesn’t come without risks, and we continue to view monetary policy uncertainty and the recent breakout in both the dollar and Treasury yields as major headwinds for continued equity market momentum.
October is off to an impressive start, with the S&P 500 trading up just over 4% as of October 17. The rebound follows a dismal September that left the market oversold and clinging to support near the rising 200-dma. However, buyers quickly came back into the market to take advantage of the dip, as earnings optimism, signs of a potential peak in Federal Reserve (Fed) tightening, continued economic resiliency, and easing oil prices helped offset concerns over building Treasury market volatility.
As shown below, the pullback off the July 31 high found support just above 4,200 earlier this month. This key support area coincides with previous highs and lows, an uptrend off the October lows, and the rising 200-dma.
The middle panel of the chart shows the BPI for the S&P 500. The BPI represents the percentage of stocks within the S&P 500 with a current Point & Figure buy signal—a field of technical analysis that utilizes filtered price movements to generate buy and sell signals. BPI readings above and below 50% are considered bullish and bearish, respectively, while the BPI can also be utilized to identify overbought (readings above 70%) and oversold (readings below 30%) conditions. Earlier this month, the BPI fell to only 28.2%, marking over a two-standard deviation move below its average since 1996.
Finally, the bottom panel shows the Moving Average Convergence/Divergence (MACD) indicator. MACD combines momentum and trend following into a single indicator using convergences and divergences between a long- and short-term exponential moving average. The indicator has recently rebounded from its lowest level since October 2022, triggering a buy signal early last week.
Bullish Percent Index Signals
The big question among investors now is whether the stock rebound will continue. To help answer this question and quantify the impact of oversold conditions, we back-tested several BPI signals, including:
- When BPI crosses below 30%—indicative of washed-out market breadth/extreme oversold conditions.
- When BPI crosses back above 30%—indicative of improving market breadth/oversold conditions.
- When BPI crosses back above 30% when MACD is in a buy position—indicative of oversold conditions and market breadth improving with a bullish momentum shift.
- A minimum 10-day filter was applied to eliminate overlap in signals.
As shown below, oversold BPI readings of this magnitude have historically represented buying opportunities for stocks. The S&P 500 has posted respective average one-, three-, and six-month returns of 2.7%, 6.1%, and 8.8% after the BPI crosses below 30%. Returns generally skew higher for BPI crosses above 30%, especially on a six- and 12-month basis when a MACD buy signal accompanies the crossover.
SUMMARY
Technical evidence is building for a sustainable S&P 500 recovery off the 4,200 area of support. Momentum has turned bullish after reaching historically oversold levels earlier this month, and historical comparisons to similar inflection points point to above-average market gains over the next 12 months. Of course, the recovery doesn’t come without risks, and we continue to view monetary policy uncertainty and the recent breakout in both the dollar and Treasury yields as major headwinds for continued equity market momentum. While the overall technical backdrop has improved for stocks, interest rate stabilization (at minimum) will likely be key for continued upside in the fourth quarter.
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.
Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value