Over the past 13 trading sessions, the benchmark S&P 500 Index climbed 7.6%.
It’s a big move in a short time. One that has many people asking if the correction is over… and if it’s safe to “go big” in stocks.
Our answer: We’re not out of the woods just yet. The recent rally is encouraging… But there are a few major obstacles the market has to overcome first…
In today’s essay, we’ll review our current investment thesis… And we’ll show you the three things to look for before getting aggressive with new stock purchases.
First, let’s discuss the 200-day moving average.
A lot of professionals like to use the 200-day moving average to size up a market’s long-term trend. It works by collecting an asset’s closing prices from the past 200 days, then taking the average of those prices. This produces a chart line that “smoothes out” market volatility.
There are two main things to consider when looking at the 200-day moving average:
- During bull markets, stocks tend to spend most of their time above the 200-day moving average. During bear markets, they spend most of their time below it.
- If the 200-day moving average itself changes direction, there’s a good chance a new big trend is underway.
You can get a good feel for these two ideas in the 20-year chart below. It shows the S&P 500 and its 200-day moving average. As you can see, during each of the three bull markets, the S&P 500 traded mostly above its 200-day moving average. And during the two bear markets, the S&P 500 traded mostly below it. The arrows show the seven times the 200-day moving average changed direction for at least a month.
As of August 21, the S&P 500 has traded below its 200-day moving average… and the 200-day moving
average itself has been moving lower. You can see this more clearly in the four-year chart below.
For now, the trend is down. And we remain cautious on stocks. If investors can push the S&P 500 back into an uptrend, we’ll be much more comfortable adding to our stock holdings and even speculating on higher prices.
Before we’ll trust the uptrend, though, three things need to happen:
- The S&P 500 needs to break above its 200-day moving average,
- The 200-day moving average itself needs to turn higher, and
- The S&P 500 needs to close above the 2,131 level.
No. 3 may be the final hurdle… Or it may come before the 200-day moving average turns higher. Either way, as we explained in our September 8 essay, we believe the stock market will only offer significant potential gains if the S&P 500 breaks 2,131 to the upside. Until then, the broad market is in “no man’s land.”
As you can see in the chart below, 2,131 (2,130.82 to be exact) is the all-time high for the S&P 500.
Old highs (like old lows) are important psychological levels. A move above 2,131 would mean investors believe the global economy is strengthening, not weakening. It would mean corporate profits are strong enough to shrug off today’s big worries, which include a recession in China, excessive corporate and government borrowing, and a strong U.S. dollar.
If the stock market were to break 2,131, it would go a long way toward repairing faith in the economy and the stock market.
The rapid 7.6% jump in stocks feels good. But that doesn’t mean it’s time to get aggressive… Until our three criteria are met, the stock market is “guilty until proven innocent.” The downside risk in stocks is larger than the upside potential.
So for now, our advice remains the same: Confine your stock purchases and trading to only the most attractive opportunities. Try some short trades. And keep plenty of cash on hand for any great buying opportunities that turn up.
Regards,
Brian Hunt and Ben Morris
Further Reading:
“If the S&P 500 falls 20% in the next year, how will your stock holdings perform?” Brian and Ben write. “If the S&P 500 climbs 20% in the next year, how will your stock holdings perform?” Thankfully, there’s a stock market strategy that allows you to make good money in either of these outcomes. You can learn all about it right here.
Brian and Ben say one of the simplest – and most important – ideas in all of investing is asset allocation. “It could save you hundreds of thousands of dollars over the course of your life,” they write. Get all the details here.
