The 103 point (3.5%) drop in the Dow Industrials on Monday February 24th caught many investors by surprise. The additional decline of almost 900 points by the middle of the next market day had many investors panicking.
Unfortunately there have been clear warning signs for the stock market over the past month or so but too many investors get caught up in the fear of missing out (FOMO). Also some investors have not taken the time to educate themselves about the stock market and have accepted the wild bullishness of the financial media.
Our editor Tom Aspray, who also happens to be a former biochemist, has been warning investors that there was no way to know the impact of the coronavirus on the financial markets or economy. Therefore he has been warning about the stock market risk. Of course the human toll is much more important, and that is likely to get worse. A true picture is unlikely to emerge for weeks if not months.
On January 19th just after the Dow Industrials made a new high at 29,373 Tom contributed an article to Forbes.com titled “Investors Get More Bullish. Isn’t Investing Easy?” where he commented in jest as investing is not easy …
Based on my many years of experience, I see these sentiment and starc band readings, along with the attitudes of investors, traders, portfolio managers, and pundits, as a sign of worrisome high levels of complacency. In fact, one investor told me last week that he did “not need to understand the stock market, because it only goes higher”.
In addition Tom pointed out that the “latest survey from the American Association of Individual Investors, the percentage of bullish investors (Bullish %) rose 8.76 points to 41.83% which is just below the December readings of 41.89% and 44.09%. As a reminder, high Bullish % readings can often mean there are fewer investors to buy, as they're already invested.”
The stock market did correct in late January but rebounded in early February as the market bulls bought stocks like Apple, Tesla and Virgin Galactic with wild abandon. On February 17th Tom noted it was “A Historically Overbought Market”. As the chart indicates this article was released two days after the market peaked on February 12th.
In the article Tom pointed out that the market-leading Invesco QQQ Trust (QQQ) which tracks the Nasdaq 1oo index was already “up 10.3% YTD. Based on Morningstar’s Total Return data, this already exceeds the yearly performance of the QQQ in 2011, 2015, 2016 and 2018.”
He also commented that “It was another week that investors showed little concern over the spread of the coronavirus… Investors seem to be focused on their belief that, no matter what happens, the Federal Reserve can protect the interests of stock investors. Earlier this month, Tom discussed how to use advance/decline analysis along with sentiment data to identify worrisome sentiment extremes.
The decline in the stock market on Friday February 21st was a strong sign that stock market investors were now facing the reality that the coronavirus was likely to impact the economy and stock prices.
In his February 23rd article “Market Risk Hits Home” he shared some of the measures that he will use to identify the next good risk entry point in the stock market.
Tom watches the % of Nasdaq 100 stocks that are above their 50-day Moving Average (%NDX). A reading above 80% is consistent with an increased level of risk as most of the stocks have already moved higher.
Often before the NDX tops the %NDX can start to diverge, and this warns of a correction. This was the case in April (line a). A smaller divergence formed in August (line b), before the tariff-triggered decline.
The %NDX formed a series of lower highs over the past month (line c) and with Tuesday sharp market decline the %NDX has now dropped to 25. Even though there are no signs that the market decline is over the %NDX has now dropped into a lower-risk buy area.
This method identified low-risk entry points in June, August and October (see arrows) and Tom is confident that the bull market is not over. Therefore his technical and sentiment analysis will allow him to tell both his Viper ETF and Viper Hot Stocks clients when to get back in the market.