Is Another October Bearish Climax Ahead?
The sentiment on Wall Street is getting highly bearish, for good reasons. Sside from volatile stocks and rising bond yields, so called “soft data” suggests that consumer confidence is rapidly failing, new home sales are falling, and that inflationary expectations aren’t budging. In addition, comments in a recent Dallas Fed survey continue to point to high grades of pessimism among employers.
The recent fiscal fourth quarter 2023 operating results from warehouse wholesale club Costco (NSDQ: COST) suggest that the Federal Reserve’s interest rate increases are reaching a critical point.
Costco’s results beat Wall Street expectations on the top and bottom lines. It turns out that customers were buying groceries instead of big ticket items, which boosted the company’s margins. That’s another sign that consumers’ wallets are getting tight.
Costco shares are worth watching in this market, because a negative reversal in the stock would suggest increasing pessimism on the part of investors in their view of the state of consumer finances.
Yet, as I’ve often noted here, it’s usually when bearish sentiment climbs that proverbial wall of worry to seemingly never ending heights that profitable buying opportunities develop.
Familiar Ground Thanks to the Fed
It was almost a year ago that the market was fretting about similar issues including government dysfunction (the usual fall season shutdown games), rising inflation, a hawkish Federal Reserve and seemingly never ending higher interest rates, fear of geopolitical event risk and the potential for a global recession. The upshot was that in October 2022, the U.S. Treasury Ten Year Note yield (TNX) was at what were then multi-year highs.
Of course, any one of those metrics can cause a major market meltdown. And yes, it is prudent to keep them in mind.
But here’s my point. As I described way back in October 2022, just as the market’s fear gauges were exploding to the upside, a bottom for stocks developed which preceded a nifty rally which essentially peaked 10 months later in August 2023. You may have noticed, things are starting to look the same.
Indeed, there are no guarantees. But to ignore the parallels between current market signals and previous similar ones would be imprudent.
One of my favorite fear gauges is the CNN Greed-Fear Index, a composite of technical and sentiment indicators which has an uncanny ability to pinpoint extremes in market sentiment. As with all contrarian indicators, when this one shows extreme fear (low readings) or extreme greed (high readings), it’s worth anyone’s time to review their portfolio and pay extra attention to the market.
The current low reading (9/26/23) was 26, a cautionary number bordering on extreme fear which registers when readings fall below 25. A year ago, just a few weeks before the October bottom, this index delivered a very bullish reading of 17.
These types of readings on this indicator are music to a contrarian investor’s ears.
Another commonly used fear gauge is the venerable CBOE Put/Call ratio (CPC), which measures the volume of put options purchased versus call options for stocks. As with the CNN Greed-Fear Index, above, contrarian investors look for high readings which indicate that options traders are buying larger number of put options than call options. Put options are bets that the market is going to fall, while call options are bets that the market is going to rise.
When the number of put options greatly exceeds the number of call options, the ratio rises to a level which indicates that there are few bulls left in the market and that a turnaround is likely. That’s precisely what happened in December 2022 when the ratio rose to 1.9 as the October 2022 bottom was completed and the market took off.
Currently, the CBOE Put/Call ratio is printing above 1.0 regularly, which is considered moderately bullish, tracing a similar pattern to what it was doing prior to its climactic reading in December 2022.
A third fear gauge is the CBOE Volatility Index (VIX). This index measures the volume in put options for the S&P 500 index (SPX). Where it differs is that it offers a better glimpse into what type of hedging goes on inside the markets, and is an indirect measure of what market makers and other big money pros, the major driving forces of the market’s trend are doing. You can view the details for VIX in the context of the whole market in the composite chart below.
You can see that back in October 2022, VIX was falling prior to the market’s bottom, an indication that savvy investors were decreasing the volume of their bearish bets, even as the Put/Call ratio was rising. In other words, the pros were setting up for a rally as the general market was increasingly bearish.
The VIX currently hovers at over 19. A key chart point to watch in this indicator is the 20 level. If the selling in the current market does not trip a VIX move above 20, it may signal that the smart money is not panicking.
The Market Gauges
During rocky trading periods it pays to look at the stock market’s inner workings (the market’s breadth) for clues. That’s because the market’s breath, the difference between the number of advancing stocks versus declining stocks is a much clearer picture of whether money is coming into or leaving the market than what capitalization weighted indexes can offer.
This is due to the distortions of the index’s price by large stocks such as Apple (NSDQ: AAPL) and Microsoft (NSDQ: MSFT), which roughly account for 13% of the weighting of the S&P 500 Index (SPX).
For this I use the New York Stock Exchange Advance Decline line (NYAD). In NYAD, every stock counts the same as any other, regardless of its capitalization. Thus, when the line is heading up, it’s a clear sign that the overall market is in an uptrend. The opposite is true when the line is heading down.
Recently NYAD has been falling. Yet, it’s nearing a major long term decision point as it tests the support of its 200-day moving average. When NYAD trades above the 200-day line it means stocks are in a bullish trend. Thus, the current testing of this key technical support level is important for investors to note. If NYAD holds the line at the 200-day and rallies it would signal that the correction is over.
A closer look, reveals that in October 2022, the RSI indicator for NYAD was near the 30 level, which signifies an oversold condition. Moreover, the RSI for NYAD in the present is also near the 30 level, which means that NYAD is nearing an oversold level now, as it tests the 200-day moving average.
An equally important and often ignored indicator is the U.S. Ten Year Note Yield (TNX). This interest rate is the benchmark for 30 year mortgages. As TNX goes so does the housing market, which accounts for an estimated 15% of U.S. GDP.
Currently, TNX is at a multi-year high, stubbornly trading above 4.5%. Note also that TNX recently traded well above its upper Bollinger Band (green envelope line above and below the yield), which define an asset’s normal trading range. That’s a big deal because anytime a trading instrument is that far above its normal trading range, it’s often a prelude to a major trend reversal. Moreover, TNX did the same thing in October 2022 just before reversing aggressively and spurring the bottom in stocks.
History is Worth Reviewing
The month of September is well recognized as the market’s worst performing month of the year. This September is proving to be no exception to the historical norm. On the other hand, market bottoms often develop in or near the month of October.
October 2022 and the ensuing rally is a great example of this seasonal occurrence. In other words, an increase in bearish market sentiment is usually a prelude to a major market bottom and a significant buying opportunity.
So, as the month of October approaches there are familiar signs of important sentiment shifts and significant technical developments appearing which suggest that a traditional October bottom in stocks may be forming.
Stock prices can certainly fall further. That’s because oversold markets can stay oversold for much longer than anyone can guess, and there are plenty of things in the world that can go wrong at any time. The flip side is that the longer the market stays oversold, the greater the chance that when the bottom develops, the rally that ensues will be larger than the majority may expect.
I, for one, am making my shopping list.
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