Markets tend to move from one extreme to another.
After a brutal start to 2022, bulls are finally in the driver’s seat. Money is flowing into stocks.
The last few weeks have seen stocks reprice in dramatic fashion. Since our oversold signal flashed on July 14th, the S&P 500 has gained 11.08%. In those 4 short weeks, markets were given the green light as capitulation selling ground to a halt.
Add in yesterday’s CPI print, which showed inflation came in cooler than expected, and you have a playbook for money managers to add risk… especially those on the sidelines waiting on a positive macro development.
For weeks money’s been put to work in dramatic fashion.
So, you may be wondering if this massive shift to risk-on post oversold is a fluke or normal. Today we’ll look at prior oversold periods and calculate how long it takes for markets to reach overbought territory. Believe it or not, extreme selloffs often preface rapid climbs in stocks.
But first, let’s check in on the one-way action of Big Money flows. The bull train has left the station.
Money Is Flowing Into Stocks
As noted last week, signs of a new bull market were forming. Our most popular indicator, the Big Money Index, has exploded higher. It’s now breaking above 70% as money is flowing into stocks.
In fact, this latest lift has pushed the BMI to YTD highs. We could be weeks away from reaching the red overbought area of 80%. Check it out:
This massive pendulum swung from a 25% reading (green line) to today’s 71% is massive. But get this, steep moves higher in the BMI are natural after bear market pivot points. When the crowd is positioned one way (short), a stampede higher can ensue… and often does.
To prove this, let’s look at recent prior oversold periods pre-2022. You all remember the Pandemic market crash. Our BMI went oversold on March 19th, 2020, and the rally started days later. The BMI went overbought in less than 2 months:
An oversold BMI often explodes out of oversold conditions like a coiled spring being released. Intuitively that makes sense. As most market participants are underweight stocks during crashes, demand eventually returns prefacing a wicked rally.
That’s how the stock market works.
Let’s keep going. In Q4 of 2018, the BMI reached oversold twice… eerily similar to today’s market environment.
Below you’ll notice how we breached oversold in October and had a swift near-term rally, but then it failed. The 2nd oversold reading hit on Christmas Eve.
Christmas 2018 came right on time for the stock market. Conditions became overbought nearly 6 weeks later:
This is another case in point where extreme down-moves often trigger explosive up-moves.
Let’s do another example. In early 2016, stocks were creamed sending the BMI into the rare green zone. Just 6 weeks later markets were overbought:
Clearly money flows flipped, and fast! The window of opportunity can close quickly. That’s exactly what’s going on right now. Extreme bearishness and positioning created quite a bullish setup.
But let’s drive home the point one last time. I went back and isolated all 22 oversold periods going back to 1990. I calculated how long it took on average for an oversold market to become overbought. I was surprised at the findings.
Check it out. Below, started from left to right you’ll see the first day the BMI hit oversold. The next column lists the first day the BMI reached overbought post an oversold reading. Next, you’ll see how many days and months it took for each oversold period to flip to overbought. Finally, off to the right details the return of the S&P 500 throughout each period:
Based on 20 oversold instances, it takes nearly 4 months for the market to become overbought. Also, the market tends to gain 5% on average during those periods.
But I want to point something out. Half of all oversold instances took less than 3 months to reach overbought. So, be careful getting too bearish for too long.
While the BMI is rising like a phoenix from the ashes right now, it’s behaving in-line with history. Money is flowing into stocks. And it’s completely expected!
Let’s wrap up.
Here’s the bottom line: The latest rally isn’t surprising based on history. Oversold conditions often preface monster rallies – many times within a few months.
Equities are being accumulated. Money is flowing into stocks. It’s not popular, but the odds were stacked in the bulls’ favor for many weeks.
Data has a way of cutting through the noise.
When the macro is hard to follow, trust in data.
***Finally, our buy lists are full of growth stocks getting accumulated. If you’re a stock picker or a professional looking for unique data insights, consider a MAPsignals subscription today. Analyze and become a better investor.