Mid-week market update: The stock market gapped down on Monday on China Evergrande contagion fears. The technical outlook darkened further Tuesday when a rally attempt failed. The markets took on a risk-on tone this morning when Evergrande issued an ambiguous statement that a coupon due on its yuan-denominated bond. An agreement had been reached with its lenders but the statement didn’t specify the nature of the payment, or when it would be paid.
While today’s rally is constructive for the bulls, the S&P 500 has yet to fill in the gap from Monday’s downdraft.
Was that the bottom?
Market bottom models
Three of the four components of my short-term market bottom model flashed signals on Monday. The 5-day RSI was deeply oversold; the VIX had surged above its upper Bollinger Band, and the NYSE McClellan Oscillator had fallen into oversold territory. The near-miss was the failure of the VIX term structure to invert, though it did briefly invert intraday Monday. Barring the appearance of further negative fundamental drivers, historically this has meant that a short-term bottom is near.
Other historical studies indicate risk/return is skewed to the upside. The % of S&P 500 stocks above their 10 dma is in extreme oversold territory. In the 18 instances over last five years, the 30-day subsequent median return return was 4.6%, wich a success rate of 83% – and that study includes the COVID Crash.
Rob Hanna at Quantifiable Edges
also found that a three-day consecutive decline into an FOMC day has historically resolved bullishly.
Not out of the woods
Even though the historical studies show that risk/reward is skewed to the upside, bullish traders and investors are not totally out of the woods. Washington is still embroiled in a debt ceiling battle and Mark Hulbert
has documented that the market does not perform well ahead of such deadlines, which is expected to be September 30.
I interpret current conditions as a bottom has either been reached, or the market is forming a complex W-shaped bottom. Downside risk should be limited unless the market is presented with another unexpected shock, though traders should be prepared for a retest of the old lows next week as debt ceiling anxiety continues.
Disclosure: Long SPXL