Can indices recover from here?

We look at indices following the recent sell-off, to see if there are signs of a bounce. 

US 500
Source: Bloomberg

We find ourselves in a similar position to the beginning of February, when markets suffered heavy reverses.

Following this, US markets rebounded, with the NASDAQ 100 in particular moving to a new record high. But this ‘V-shaped’ recovery evidently contained a trap for the unwary. Since the mid-March highs indices have fallen back, and in some cases have moved below their February lows.

But this may not be the beginning of another big leg down. Breadth has taken a huge knock too, with the percentage of S&P 500 stocks above their 20-day moving average falling to 18.3%, its lowest level since mid-February. This is the kind of reading that is usually followed by a bounce, even if only in the short term. Indeed, a back-test on this suggests that when the breadth figure is this low, the average return over the next 60 trading days was 3.2%.

Another sign of a possible near-term bottom is to be found in the TRIN index (short-term Trading Index). This is another breadth indicator that is derived by dividing the advance-decline ratio (the number of rising stocks/number of falling stocks) by the advance-decline volume ratio (total volume of rising stocks/total volume of falling stock). This hit 2.1 yesterday, an impressive rally. The TRIN index usually moves inversely to the S&P 500 index, and such spikes are followed by rallies.

Then there is sentiment. The CNN ‘Fear and Greed’ index has been sitting firmly in the ‘greed’ end, but yesterday it fell to nine, indicating ‘extreme fear’. Warren Buffett notes that investors should be ‘greedy when others are fearful’, so this would appear to be a time to err on the greedy rather than fearful side.

Finally of course there is the price. The S&P 500, a better index than its more famous cousin the Dow Jones, due to its broader make-up and market-cap weighted price (as opposed to the Dow’s 30 stocks and price-weighted price) makes it more representative of both US and global equity markets.

The index fell sharply, below the 2647 low from early March, but for now it has held 2628, and crucially remains well above the lows of February at 2531. In addition, the index is currently in a broadening formation (green lines on the chart), and it has bounced off the bottom line, having fallen back from the upper one earlier in March. If history were to repeat itself, we may see a move above 2800. A close below 2596 would negate this, and suggest a test of the 200-day simple moving average (SMA) at 2592 and then the February low at 2531.

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