- The stock market has some work to do before it hits bottom and moves higher, according to Ned Davis Research.
- The research firm highlighted the four things that need to happen for the stock market to bottom.
- Stocks have seen fits and starts in rallies that eventually get sold as investors are overwhelmingly bearish.
Stocks continue to stage head-fake rallies that eventually get sold to new lows as investors turn increasingly bearish on the market.
That can be seen in Tuesday's trading action, with the Nasdaq 100 falling more than 3% after staging a rally on Monday. The Nasdaq is down nearly 30% year-to-date, while the S&P 500 is down about 18% over the same time period.
To avoid the frustration of trying to invest and catch the bottom during a market decline, Ned Davis Research put together a list of the four things that need to happen before a bottom can truly be in for stocks.
"Financial markets are forward looking, so price-based, or technical, indicators are likely to be the first to signal the downtrend has turned into an uptrend," NDR said. These are the four steps the market typically follows to establish a sustainable bottom and rally in stocks.
1. Oversold
"The first step is for the market to fall to deeply oversold levels. By several objective measures, the market can be described as oversold," NDR said, highlighting that the S&P 500 has dropped for seven straight weeks, trailing only the losing streaks in 1970 and 2001. "The selling has been relentless," NDR said.
2. Rally
"Each cycle is different, but at some point, the sellers become exhausted, and the market posts a multi-week rally," NDR said, highlighting that the average rally after a waterfall decline like the market is currently experiencing lasts a median of 25 days with gains of 14%.
"Importantly, look for broad participation on rallies, including an expanding percentage of stocks above their short-term moving averages and upside volume," NDR said.
3. Retest
"Most post-waterfall declines experience retests," NDR said, while noting that prior waterfall declines in 2018 and 2020 did not. "For that reason, we would still look for a retest, but leave open the possibility of the market skipping step three," NDR said.
"A successful retest does not necessarily mean that the popular averages have to stay above their waterfall lows. Only
three of the 12 retests did so... Instead, look for positive divergences, such as fewer sectors and stocks making new lows, as well as less total volume and less downside volume," NDR said.
4. Breadth Thrusts
"The early stages of a sustained uptrend often include most stocks rallying together. That way, if a few industries falter, plenty of others can support the popular averages. An extremely high percentage of stocks rallying is called a breadth thrust," NDR said.
"The bottom line is that the market has achieved the first step (oversold) and is attempting the second step (rally). Until the market can move to step four (breadth thrusts), we view the [bottoming] process as ongoing," NDR concluded.