The stock market has been in one of its worst losing streaks since the dot-com bubble burst.
The Dow Jones Industrial Average saw declines for eight straight weeks. It’s the first time this has happened since 1923.
The S&P 500 fell for seven weeks in a row – its worst performance since 2001.
And out there in the market, many people have been running for the hills. They think the market is going to head lower for the foreseeable future.
Yet there are several reasons to be hopeful.
In fact, in today’s essay, I’ll share five reasons I believe stocks are heading back up soon – and could even return as much as 15% in the near future.
Reason #1: Overpunished Stocks
Wall Street uses the term “bear market” for when an index falls 20% or more from a recent high for a sustained period of time.
The Dow is heading towards bear market territory. It has dipped as low as -14.5% this year.
The S&P 500 too is flirting with a bear market. It’s currently around -13% year-to-date after dipping as far as -18.5%.
Meanwhile, the Nasdaq Composite is still down over 23% this year.
Stocks are getting so beaten down that they are now hitting undervalued levels. Some companies’ assets alone are worth more than the value of their stock.
And for us, that means stocks are hitting discount levels, which often coincides with buying picking up.
Reason #2: Margin Is Fleeing
Margin calls have been killing the markets. This ultimately isn’t a bad thing, as we’d reached nosebleed levels. But forced selling has driven the recent weeks of selling to extreme levels.
And we’re getting signs that margin debt is close to being “oversold”…
FINRA Margin Debt Z-Score
Source: BofA Global Research
As we can see, the Financial Industry Regulatory Authority (FINRA) margin debt “z-score” has dropped to -1.91 and is nearing oversold territory (-2).
This is its lowest point since March 2020, and it serves as a contrarian bullish sign for investors going forward.
When the z-score hit oversold back in 2002, 2008, 2018, and 2020, U.S. stocks were nearing their bottom.
Reason #3: Technical Indications
The DeMark Indicators help quantify when a trend has an above-average probability of changing direction. They provide objective clues to help us buy low and sell high.
And in essence, they tell us when to avoid chasing the prevailing trend.
Lately, we’ve seen plenty of selling. But now DeMark Indicators say that buying is soon to come.
DeMark Shows a Rally
Source: DeMark Analytics
And the creator of the DeMark Indicators is expecting as much as a 16% rally.
We can see other similar signs by looking at the relative strength index (RSI) and stochastic indicators. Stocks’ RSI ratings are at lows. Stochastics are weak.
They say that the near term is primed for buying.
Reason #4: Peak Bearishness
Bearish sentiment has taken over. Think about how quickly the state of the world has changed in the last six months.
If we go back to just November 2021, people were still buying $21 million non-fungible tokens (NFTs), and meme stockers were still full-on chasing growth and “sticking it” to Wall Street.
People were going full throttle in a bull market, and greed reached a fever pitch.
Yet more recently, many retail investors have washed out of the market.
Reality set in this year, with inflation and high gas prices, interest rate increases, another crypto crash, geopolitical conflict, monkeypox, and recession fears knocking greed down.
Like the flip of a switch, the market turned bearish. And now even consumer staples stocks like Walmart and Target have gotten walloped.
In six short months, the world and our financial markets have shifted to peak fear.
High levels of fear usually coincide with a near-term bottom. Again, when stocks become highly oversold or undervalued, buyers begin to step in to pick up deals.
And for our fifth and final reason, my system agrees…
Reason #5: Big Money Is Oversold
The Big Money Index (BMI) just went oversold last week on May 25.
To track when markets hit oversold (or overbought), I developed the Big Money Index (BMI). I take all of the buy and sell signals and plot them on a 25-day moving average.
And here’s where the BMI is now:
Big institutional accounts are selling stocks at an unsustainable pace. And when selling is unsustainable, markets tend to rocket higher once the selling concludes. My data shows we should hit bottom around June 6.
As I shared last week, oversold markets on average result in very positive returns for stocks in the future.
Now, my data shows that it could take a full year for us to return 16% from here on average. Our typical return is 6.3% in the first three months after the BMI goes oversold.
Yet out of the past 20 times we’ve gone oversold, eight times we rose double digits.
If we consider the volatility that markets have been delivering investors ever since COVID first began and the 14.3% bounce back from the last time the market went oversold in March of 2020… I don’t think it’s unrealistic to expect a 12–15% rally over the next couple of months.
And if the surge of buying we saw at the end of last week is any indication, there’s plenty of pent-up buying pressure just waiting for the current selling trend to reverse…
Talk soon,
Jason Bodner
Editor, Outlier Insights