Looking at the markets is enough to cause nausea right now. Inflation fears have deeply discounted growth shares.
Yet valuations are getting silly. Tech stocks are getting so hammered that one might think we’re headed back to the Stone Age.
Far from it… and giving in to the urge to sell right now is a bad idea.
What’s hammering the sector isn’t really sentiment. It’s margin debt reduction, as I shared with readers last week.
And the data shows us that conditions are ripe for a bounce in the near future…
Lessons From History
One way to examine where markets are heading is by looking at prior periods of market pressure. While historical performance is never a guarantee, it can give us a baseline for our expectations.
Just look at the turn of the century… The spectacular fall of the dot-com bubble was based on insane valuations.
Many stocks traded at “infinite” multiples, meaning price-to-earnings ratios were infinitely high because there were no earnings! That bubble needed to pop, painful as it was.
But as we can see, when rates were low and margin went up, so did equity prices. Then they both fell.
We saw similar correlations during the Great Financial Crisis in 2008. Greed for higher yields drove Wall Street to “innovate” with risky home loans sold to pension funds and conservative investors.
The basic assumption was house prices would only ever increase. That bubble also needed to pop.
Again we saw a correlation between rising margin debt and equity appreciation during that time. Likewise, after the pop, the fall of stocks coincided with a big reduction of margin debt.
And these are just two examples… We can see a similar correlation during other past market pullbacks too.
Yet our current market volatility doesn’t have critical underlying issues like either of these historical situations. This correction doesn’t have many stocks with “infinite” valuations. Nor does it have risky loans in conservative investments.
This is simply fear over an economic slowdown and inflation uncertainty.
We do need to unwind leverage, though. Margin debt balances have reached nosebleed levels.
This is because the government gave away “free” money and offered to lend at effectively zero interest for the past several years.
Now it is unwinding, forcing stock prices lower:
We all knew the party wouldn’t last forever, and nobody wants it to end. But the cops are here, and investors are scrambling for the exits.
Once margin calls and leverage reductions conclude, however, the market will find a floor.
Once there are no sellers left, value buyers will step in.
And my Big Money Index (BMI) shows that we’re finally crossing that line…
On the Cusp of Oversold
As a reminder, the BMI tracks institutional buy and sell signals over a 25-day moving average. When selling overpowers buying, the BMI drops.
And once the BMI falls below 25%, we hit “oversold” conditions. That’s a big bullish sign when that happens.
Historically, after going oversold, average S&P 500 returns are up 9.6% six months later… 16% a year later… and 29.2% two years later.
And now, we should hit oversold any day now. We’re currently at 25.1%…
It takes an average of 9.5 trading days after going oversold for us to hit the trough. That means we could see a bounce arriving around June 6 now.
Of course, keep in mind that these are just averages.
Given that margin is such a factor in this pullback, we could see a bounce hit sooner.
Many lenders will give their customers until the end of the month to meet their margin call requirements… which means we could clear out a lot of the margin selling by the end of May.
And my data isn’t the only thing indicating a bounce coming…
More Signs of a Bottom
Another great indication that we are close to the bottom is that Warren Buffett is on a buying spree.
He recently took large positions in Occidental Petroleum (OXY), HP (HPQ), Ally Financial (ALLY), Citigroup (C), Activision Blizzard (ATVI), and Chevron (CVX).
My system saw this happening, too. Here are the recent institutional buy signals for OXY…
Buffett doesn’t buy at tops… only near bottoms.
So we have a near-oversold BMI, falling margin debt balances, and Buffett is buying!
And as I mentioned last week, over 50% of the Nasdaq is down an average of 56.7%. That’s irrational selling.
And that’s why I believe we’ll start to see stocks lift in June.
In the immediate inflationary environment, energy, food, and staples are poised to benefit.
And after the forced selling concludes, then tech will bounce – though I don’t expect the tech bull market to fully resume until there is greater clarity on the economy. Once recession fears ease and interest rates stabilize, then money will absolutely pour back into growth.
This looks possible in the third or fourth quarter of this year.
So, while I know it is miserable to sit through, my advice is don’t throw in the towel when fear feels worst. It would be a grave mistake.
After all, if the greatest investor of all time is buying right now, do you want to be the person that he’s buying from?
Talk soon,
Jason Bodner
Editor, Outlier Insights