When Will This Selling End?

Market volatility is at feverish levels.

Growth and tech stocks have led the vicious selling since November. But now everything is going on sale, including large-cap tech and other prior winning groups. It appears nothing is safe now.

There is panic selling fueled by the unwinding of leverage. And as I discussed last week, selling is being amplified by high frequency and algorithmic traders.

It seems like there’s no end in sight.

But is there?

I was just in Las Vegas to present at the Money Show. And I kept getting the same question: When will the selling end?

That’s what everyone is wondering these days.

So in today’s essay, I’ll provide an answer based on data science and historical similarities and reveal exactly when I think this selling will end.

What History Shows

Let’s start with the Nasdaq. According to a Bespoke Research report, this is the ninth time in Nasdaq history that the index fell 25% or more, going back to the 1970s. Right now, it is down more than 27% since its November peak.

The average time it took to fall 25% was 161 days. This time, it took 171 days, which is slightly longer than average.

And lastly, it took an average of 209 days to put in an ultimate low (around another 48 days after dropping 25%). And the average low was 40% from its peak.

That’s the bad news: Despite Friday’s bump, history says we may have some more downside in the near term.

The good news is, the forward returns after the index fell 25% are positive:

• One month: up 1.9%

• Three months: up 11%

• Six months: up 20.4%

• 12 months: up 33.5%

Naturally, returns varied for each period, but this metric says we are approaching grossly oversold. And that tends to be bullish for the next 1–12 months.

What interests me even more, though, is what I see in my own data…

What the Big Money Shows

My Big Money Index (BMI) is essentially a gauge for institutional money flows in stocks.

It works like this: I take all unusual large volume “Big Money” buy and sell signals and plot a 25-day moving average. This gives us a smooth indication of whether money is moving in or out of the market.

Currently, it is in freefall. Today, it hit a level of 30% – the lowest since the pandemic. This is interesting because a BMI reading of 25% or below is a deeply oversold market.

It is important to understand this is a rare occurrence; it’s only happened six times since 2014. And each time, it was extremely bullish for stocks.

Looking at BMI data since 1990, it has happened only 20 times. That’s an average of once every 1.6 years. There were a total of 410 days spent oversold out of roughly 8,150 trading days. That’s only 5% of the time.

The last time we saw a BMI oversold reading was March 2020 during COVID lows.

Now, here’s where it gets interesting, folks…

The average duration of an oversold reading since 1990 is 20 trading days… just about a month.

The average time until trough after the initial oversold reading was 9.5 trading days. Similar to the Nasdaq data above, the S&P 500 forward returns from the first oversold reading are as follows:

• One month: up 2.8%

• Three months: up 6.3%

• Six months: up 9.6%

• Nine months: up 11.3%

• 12 months: up 16%

• 24 months: up 29.2%

As you can see, the rare oversold reading is historically very bullish for stocks on average.

Subscribers to my Outlier Investor service may have heard me previously mention an oversold BMI. In fact, I alerted my readers in October and December 2018 and in March 2020.

An oversold BMI is a battle cry to buy beaten-down stocks.

And we’re about to plunge below oversold, which is why I can tell you the day I believe the market will bottom:

• The earliest we go oversold is tomorrow, Tuesday, May 17, assuming zero Big Money buy signals until then. In other words, there’s a strong likelihood of an oversold BMI next few trading days.

• Using BMI data since 1990 means the market could trough as early as June 1, if averages hold.

The bad news is, based on data, there’s potentially a little more downward volatility ahead until the sellers exhaust themselves.

The good news is, an oversold reading means stocks are grossly oversold. And this is very bullish near term.

Our Game Plan

As for our game plan… much like a hurricane, we must just sit through the storm until it passes.

Succumbing to fear while there is forced selling would be a grave mistake. By forced selling, I mean some portfolio managers are being forced to sell positions.

Oftentimes, traders employ leverage. For example, a money manager will pledge one dollar of collateral to control three dollars of risk. Leverage is embraced when market returns are strong.

For instance, the S&P 500 in 2019 was up 28.9%. In 2020, it was up 16.26%. And last year, in 2021, it was up 26.9%.

Those returns are hard for professional money managers to beat without using leverage. So leverage can work greatly in your favor on the way up.

But so far in 2022, the S&P is down 16.5%. Imagine risking three times your capital and experiencing a drawdown like that. It becomes a 49.5% loss in this example.

And leverage can even be higher than 3X, which can totally wipe out principle and force liquidation when margin calls come.

But as we can see, sellers are getting closer to exhausting themselves. Soon there will be few (if any) sellers left, and bargain-hunters will step in to lift beaten-down stocks.

And I’d encourage my readers to do the same…

• Conservative investors looking for safety should be identifying profitable large-cap companies with strong balance sheets and low debt. Ideally, they will have low price-to-earnings (P/E) ratios and pay a dividend. Stocks like these will likely see capital appreciation over the coming years as well as earn a dividend yield to help offset vicious inflation.

• More aggressive investors should be identifying heavily beaten-down areas like technology stocks. The demand for technology globally will only continue to grow. Our reliance on technology for everything from communications, computing, networking, the cloud, driving, and even washing our dishes is not suddenly going to stop because we are worried about inflation and interest rates.

Last week, tons of alerts hit my phone regarding stocks that I own that are hitting new 52-week lows.

Am I nervous? No.

Does it stink? Yes.

Am I selling? Absolutely not.

In fact, I am getting together my shopping list for pummeled stocks I want to own at bargain-basement prices. And now we have the playbook for the timing of when to act.

That time is coming very soon.

I know this volatility is unsettling, uncomfortable, and even painful to endure. But deals in stocks never resemble deals in everyday life.

We get excited when an expensive TV we want suddenly goes on sale. But when it comes to our investments, we feel bad about discounts because we worry about losing money. But it’s these times that long-term investors can make serious returns for their future.

The Big Money Index looks to become oversold as soon as this week.

The question shouldn’t be, What will I be selling? Instead, we should ask, What will I be buying?

Talk soon,

Jason Bodner
Editor, Outlier Insights