Analysis-As U.S. stocks rip higher, investors hunt for signs of market bottom

[October 19, 2022]  By Lewis Krauskopf

NEW YORK (Reuters) - Some gauges of the stock market's health are showing that the latest rally in U.S. equities may be the start of a sustained move higher, though many investors are hesitant to jump on board until there are signs inflation is cooling.

Few can blame them for being skeptical. The current gain – which has seen the S&P 500 bounce about 6.5% last week's fresh intraday low for 2022 – comes on the heels of several rebounds throughout the year that eventually crumbled. Meanwhile, markets have been gripped by stomach churning volatility lately that has wrongfooted bulls and bears alike.

If anything, the macroeconomic picture has only grown more dire, as stronger-than-expected U.S. inflation ratchets up expectations for Fed hawkishness and recession fears grow, fueling investor reluctance to participate in the recent upswing.

Still, there have been glimmers of hope. Some gauges that flashed warnings throughout the year ahead are more positive, while the S&P 500's recent pattern of big upside moves echoes those seen in prior market bottoms. Some standout U.S. earnings reports and ebbing worries around systemic risk around Britain's budget woes have also underpinned the rally.

“There are some signs of a bottom," said Ed Clissold, chief U.S. strategist at Ned Davis Research. "In terms of whether or not it is the bottom, there is still more to prove for the market.”

Improving market breadth, which shows whether a significant amount of stocks are moving in unison, is one signal that has heartened investors.
 

Just 34% of stocks hit new 52-week lows last week along with the S&P 500's low, according to Todd Sohn, technical strategist at Strategas, compared to 43% when the index made its low on June 16.

At the same time, measures of investor sentiment - including a monthly fund manager survey by Bank of America Global Research - show the highest pessimism in years, a contrarian indicator that has been a bullish signal for stocks historically.

The crowd sentiment poll compiled by Ned Davis Research, a composite indicator that includes investor surveys, option data and asset analysis, recently fell to a level that had coincided with stock reversals in March 2020 and 2011.

“If we can get some better news on the economic/inflation/Fed front there could be a pretty powerful rally," Clissold said.

Mark Hackett, chief of investment research at Nationwide, points to the S&P 500 posting five days of gains of about 2% or more in the past month through Monday, noting a similar pattern occurred ahead of bottoms in 2020 and 2009.

A specialist trader works on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., October 17, 2022. REUTERS/Brendan McDermid/File Photo

Widespread investor pessimism, improved valuations and a seasonally strong period for stocks are among factors leading Hackett to conclude that "we are awfully close to the bottom assuming we don't have some sort of massive deterioration from here.”

Morgan Stanley strategist Michael Wilson, who has been bearish on stocks throughout the year, this week said a "tradable tactical rally looks likely," with S&P 500 rising to as high as 4,000 "as good a guess as any." The index closed at 3,719.98 on Tuesday.

Not all indicators are telling a bullish story, including the comparatively contained Cboe Volatility Index, known as Wall Street's fear gauge. Reversals in stocks since 1990 have come after the index hits an average of 37, which has signaled a bout of fearful selling that then paves the way for bullish investors to take the market higher.

However, the index has not been above that level since March even as the S&P 500 continued making new lows. It was last around 30.

“What’s happening is the VIX is in this high but not super-high range and you never get that complete 'pukage' in the markets,” said Michael Purves, chief executive of Tallbacken Capital.

Sohn, of Strategas, is also eyeing the balance between puts, which are typically bought for downside protection, and calls. The put/call ratio is yet to approach a 10-day average of at least 1.2 that has historically indicated that "you are more in the ballpark of panic and fear and close to a market low," he said.

The current bear market has also been less severe than many past downturns. The S&P 500 slid as much as 25.4% this year, while bear markets since 1929 have seen an average decline of 35%, according to BofA.

Markets have bottomed when "investors have begun to contemplate materially looser monetary policy over the next six to 12 months, when a trough for economic activity is in sight, or when valuations already fully reflect a credible 'bear case' scenario," analysts at UBS Global Wealth Management wrote on Monday.

"Today, we do not believe these conditions have been fulfilled."

(Reporting by Lewis Krauskopf; Additional reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Josie Kao)

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