Opinion: When is it Safe to Buy Stocks Again? We’re not there yet, but these are the six signs to look out for

Big falls in stock markets like this one often end in a selling spree known as capitulation.

So you should know how to spot a capitulation – a sign that it’s safer to start buying. To find out, I recently spoke to some of my favorite market strategists and engineers. They offer the following indicators.

To be fair to them, they are all looking for one combination the confirmation of signals.

“It’s a pile of things, but when they start to pile up, it gives me more confidence,” says Larry McDonald of Bear Traps Report. However, for the sake of brevity, I’ll only list one or two signals at a time.

Pay attention to the highest level of negativity among investors

Verdict: We’re not there yet.

While several investor sentiment opinion polls are pointing to extreme negativity, you’re not seeing the same signal when you look at what they are actually do with their money, says Michael Hartnett, Bank of America’s chief of investment strategy.

Since the beginning of 2021, investors have invested $1.5 trillion in mutual funds and exchange-traded funds. So far, they’ve only withdrawn around $35 billion.

“This is not a surrender,” says Hartnett.

For that, he’d like to see $300 billion in withdrawals, especially if it’s fast. Similarly, portfolios in Bank of America’s retail network have equity allocations of 63%. To capitulate, we would need to see this drop to the mid-50% range. “It just isn’t,” he says.

Look for a Peak Fear Index

Verdict: Not here yet.

The Chicago Board Options Exchange CBOE Volatility Index VIX,
tracks investor fear based on options market positioning. Higher means more fear. The VIX recently hit 35, but that’s not high enough to signal capitulation, says Bob Doll, chief investment officer at Crossmark Global Investments. He would like to see moves closer to 40. He also wants more stocks to hit the 52-week low and more stocks to trade below their moving averages.

“We have evidence of some capitulation, but probably not enough to call it a significant bottom,” Doll said.

Watch out for a spike in the put/call ratio

Verdict: Not here yet.

Investors buy put options when they are in decline. You buy calls in a bet that stocks will go up. So the overall put/call ratio tells you how scared investors are. Higher means more fear. Doug Ramsey, Leuthold Group’s chief investment officer, calls this his “Desert Island Sentiment Indicator.”

To smooth out the volatility, it tracks a three-day moving average. Since 2014, capitulation lows have occurred when this ratio rose to 0.85 or higher, as you can see in Ramsey’s chart below. Most recently it was around 0.7. So it’s not there yet.

“A lot of damage has been done. Investors are scared but not really panicking,” Ramsey said. “I don’t think we’re close to a final low.”

Look for an increase in the number of shares being destroyed

Verdict: The low is in – tradable upleg.

To identify capitulations, McDonald tracks how many stocks have fallen sharply in the Bear Traps Report. For what he calls the “classic vomit,” he looks for a sharp drop in the number of stocks on the New York Stock Exchange (NYSE) above its 200-day moving average. If this falls within the 20% range, it indicates a capitulation. Most recently it was 28%. That’s close enough considering the following confirmatory indicators.

McDonald cites the NYSE’s elevated ratio of descenders to ascenders (seven to one), one of the highest levels in the past five years. And the large number of stocks that recently made new lows on the Nasdaq. That was 1,261 on May 9, also near the high of the last five years.

Conclusion: “There is a 95% chance that we have seen a capitulation to a tradable upleg,” concludes McDonald. It could trigger a 20% to 30% upside move.

But this will only be a rally in an ongoing bear market that will last a year or two.

He gives two reasons. First, most investors are very down and just want their money back.

“The average investor is so burned right now,” says McDonald. “They will sell strength.”

Next, the Federal Reserve will “break something” with its aggressive rate hikes. Likely candidate: Something in the commercial real estate market.

“They have empty skyscrapers in every big city and loans are maturing,” says McDonald. “There could be a major failure cycle.”

Look for a high-volume blow-off

Verdict: Not here yet.

A good sign of capitulation is a “selling peak,” which is characterized by a sharp drop in large volumes, says Martin Pring, editor of the InterMarket Review Investment Letter and author of “Investment Psychology Explained,” one of my favorite stock market books. Often this can be done with a big morning rush and recovery, followed by relative rest. So far, we haven’t seen a high-volume sales peak.

Watch out for a sharp drop in margin debt

Verdict: Not here yet.

SentimenTrader’s Jason Goepfert likes to see a sharp reduction in margin debt on brokerage accounts as a sign of capitulation. How large? He’s aiming for a 10% drop each year. The current decline is just 3% to $799 billion.

Goepfert has at least 12 indicators of surrender, and only three suggest we’re there. They are: The IPO drought; several consecutive weeks of equity fund outflows of $10 billion; and extreme lows in investor sentiment surveys.

Among other signs, he’d still like to see at least 40% of NYSE stocks at 52-week lows (we’re close to 30%); less than 20% of the S&P 500 SPX,
stocks trading above their 200-day moving average (currently 31%); and an increase in the correlation between stocks in the S&P 500.

When investors hate everything, it’s a sure sign that they probably can’t get much more bearish.

Michael Brush is a columnist for MarketWatch. He publishes the market letter, polish stocks. Follow him on Twitter @mbrushstocks. Opinion: When is it Safe to Buy Stocks Again? We’re not there yet, but these are the six signs to look out for

Brian Lowry

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