How the Sausage is Made

Stock market bottoms are like sausages…

It’s not pretty to watch how they’re made, but the end result is delicious.

Last week’s action in the stock market was ugly.

The S&P 500 is back down to the early October lows. It closed Friday below its 200-day moving average line, which is widely viewed as critical support.

And with all of the geopolitical concerns around the globe, buying stocks is the last thing most investors feel like doing at this point.

But from a risk/reward perspective, it’s certainly better to be a buyer of stocks today with the S&P 500 near 4200 than it was last week, or even back in July.

From a technical perspective, we have a much better setup for a stock market bottom today than we did earlier this month.

Regular readers will recall that two weeks ago we pointed out that the broad stock market was setting up for a bounce, but we didn’t yet have the setup for a sustainable rally.

The problem was that October bottoms usually occur with positive divergence on the momentum indicators. And two weeks ago the daily chart of the S&P 500 didn’t show any divergence.

That problem has now been solved.

Take a look at this updated chart of the S&P 500…

Similar to what happened last October, the S&P 500 has made a lower low, but the technical momentum indicators at the bottom of the chart are all making higher lows.

This sort of positive divergence often occurs at the end of a decline phase and leads to the start of an intermediate-term rally phase. We didn’t have this divergence in place two weeks ago. So all we got was a modest bounce off of oversold conditions.

Now though, after last week’s ugly action, the conditions are in place for a sustainable rally into the end of the year.

Of course, there aren’t any guarantees.

For reference, though, traders who bought into this same type of setup last year enjoyed a 14% gain in the S&P 500 within six weeks. A similar move this year would have the index trading at new highs for the year by Christmas.

Best regards and good trading,

Jeff Clark

Will you take advantage of these actions or hold off?

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