The month of October has been a rough one for stocks as the market took a significant down-turn due to a combination of negative outlook on global growth, increasing interest rates, and poor earnings reports. However, this market downturn provides an opportunity to buy very high quality stocks at discounted rates if timed correctly. The tough thing is timing the market perfectly so that you are not attempting to catch a falling knife and instead investing at the bottom of the cycle or when the market is beginning to recover.
One of the main reasons why the market has performed so poorly in October is the pairing of earnings reports missing expectations and the VIX reaching high levels. The VIX, which is commonly referred to as the “investor’s fear gauge”, tracks the volatility of the market with a high VIX signaling a volatile market. The VIX often fluctuates between 10-15 when the market is healthy but as of today it is at 24.16. When the VIX is at high levels like this and a company like Amazon (AMZN) reports a decrease in future estimates the reaction to this bad news is much more significant than it would be in a healthy market environment. Relatively poor earnings by large tech companies such as Amazon and Alphabet (GOOG) along with disappointing earnings from large multinational corporations such as 3M (MMM) and Caterpillar (CAT) feed the VIX to reach higher levels and negatively effects the entire stock market.
To catch this market correction at the perfect moment in order to buy good stocks at their lowest value we can look at the S&P 500 and try to predict when the market might begin recovering and hence forth decrease the VIX. As can be seen in the chart above, the S&P 500 Index (SPX) has moved below the 200-day moving average (purple line). This a very bearish signal as this means there has been a change in polarity and the 200-day moving average, which was formally a floor of support, has now become a ceiling of resistance. This means that when SPX accelerates back up to the 200-day moving average from its current level the market is expected to bounce off of this line and trend down again. A general rule of thumb is that volatility will persist as long as the market is below the 200-day moving average.
For short-term trading, it may be a good idea to buy right now as it appears that the market may be at another level of support. I calculated this by comparing the price channel above the 200-day moving average to the current channel below the moving average.
Previous High – (200-day MA at time of cross) = (200-day MA at time of cross) – New low
2,941 – 2,800 = 2,800 – 2,659
With SPX currently at 2,658.69 we may be seeing the bottom for this cycle and I expect the next few days to feature positive movements. A short-term trader could take advantage of this. However, for long-term investors I would advise you to wait until SPX crosses the 200-day moving average and volatility subsides in order to make sure that the upward movement is not just a short cycle but a long-term trend moving forward.