X

Opportunity in a Capitulating Market

This happens when a stock’s momentum feeds on itself...

On March 22, the S&P 500 closed at 4511.

Some were calling for new highs.

After all, the market was only 6% off that mark and just recovered the entire drawdown from the Russian invasion. It even rallied from the Fed’s first rate hike.

Momentum was on the market’s side.

But for the market to rally to new highs, valuations would also need to hit new highs.

This was impossible, given that it would place multiples right back to “dot-com” bubble levels…

That’s why on March 22, I wrote

The market will trade at its long-term average earnings multiple of 17.75X… that would translate to an S&P 500 price level of right under 4,000 – a level I think we’ll get to faster than 4800.

Last week, the index overshot that target to trade down to under 3900 before finally recovering and stabilizing at 4000.

That’s despite the many troubling developments in the market such as the fallout in cryptocurrencies, China’s evolving economic disaster, and a capitulation due to margin selling.

But it seems that valuations have become attractive enough to ensure that the May 12 low of 3859 will hold… at least until we’ll get fresh guidance from companies reporting earnings in July.

On top of that, technical indicators like the Volatility Index (VIX) have been giving off signals that the market is deeply oversold.

For instance, take a look at this chart of the S&P 500 and the VIX…

The VIX started heading lower on May 9…

Yet, stocks continued to drop for another three days before finally bouncing.

When stocks fall, volatility rises. But in this case, stocks and volatility were falling in unison.

You can’t have it both ways for any material stretch of time.

This tends to happen when momentum feeds on itself and capitulates – with margin selling toward the end of the move, as we’re seeing now.

My favorite example of divergence between volatility and stock prices occurred in January 2018… where the reverse happened.

Stocks kept rising with tiny intraday ranges, and the VIX started rising as well toward the end of the month.

This was a prelude to what has become known as “Volmageddon” – when the market crashed 10% in 9 days.

We’re not going to see a complete mirror image of those events now, just a small relief bounce.

But for traders, a smooth 2-3% move can generate big profits.

One area to target is 4150 – the price level on the S&P 500 right before the most recent Fed meeting on May 4.

The chart below shows how there’s quite a bit of room for the market to run before it retests those levels…

This would also coincide with testing the 21-day moving average (MA) – a short-term technical indicator that gets touched more than once a month on average.

Right now, that level is at 4185.

And since the S&P 500 has been trading lower lately, that average over the last 21 days will come down as prices rise – and will likely meet right around 4150.

Free Trading Resources

Have you checked out Jeff’s free trading resources on his website? It contains a selection of special reports, training videos, and a full trading glossary to help kickstart your trading career – at zero cost to you. Just click here to check it out.

Although the setup is in place for a rally, the fear of an outright recession guarantees the market will stall there…

It’ll likely begin oscillating up and down between 3900-4200 for a while.

The only thing that’ll get us out of this range is reconciliation on the economy…

The Fed will either engineer a soft landing, the economy re-gains (at least) part of its growth rate, and analysts start upgrading earnings projections.

Or a recession will be imminent.

That’ll take at least a couple of months to resolve. There won’t be enough information until then.

So until then, investors should keep a neutral stance toward the market, and be nimble enough to play a 10% wide range.

Regards,

Eric Shamilov
Analyst, Market Minute

Reader Mailbag

Are you hoping for a rally or preparing for another recession?

Let us know your thoughts – and any questions you have – at feedback@jeffclarktrader.com.