This Investor Sentiment Gauge Has An Incredibly Successful Track Record For Predicting Stock Market Lows |  The Motley Fool

This Investor Sentiment Gauge Has An Incredibly Successful Track Record For Predicting Stock Market Lows | The Motley Fool

What a difference a year makes! In 2021, the worst drop suffered by investors was a 5% subaltern fade in the benchmark S&P500 (^GSPC 0.92%). This year, the S&P 500 has anchored itself in a bear market, with a 28% decline from peak to trough. Additionally, he produced his worst first-half comeback since Richard Nixon was president.

Other widely followed indices also performed poorly. The timeless Dow Jones Industrial Average (^ DJI 0.10%) briefly entered a bear market with a peak drop of 22%, while the tech-driven market Nasdaq Compound (^IXIC 1.88%) fell 38% over the past year.

Image source: Getty Images.

The $64,000 question: Where will the stock market bottom?

The uncertainty and rapidity of bearish movements during bear markets can play on investors’ emotions and force them to make rash decisions. This is what makes new investors and regular investors wonder when and where the stock market will bottom out.

To be perfectly blunt, if there was an infallible indicator that accurately predicted when bear markets would occur, how long the decline would last, and where the bottom would be, every investor on the planet would be using it by now. Since the catalysts differ for each decline in the stock market, and investors’ emotions/reactions are never exactly the same to these declines, there’s simply no concrete way to know in advance when and where. the stock market will bottom out.

But that doesn’t mean there aren’t indicators that have an exceptionally successful track record in guiding the investing community in the right direction.

Over the past two months I have looked at a number of metrics that offer a long history of (fairly) accurate prediction of when bear markets will occur, how big the decline will be or when/when the market stock market will bottom out. . This includes everything from valuation-based indicators to traditional metrics like outstanding margin debt. I even recently proposed a correlation between Federal Reserve monetary policy and stock market lows.

But there is yet another way to predict stock market lows: sentiment-based indicators.

A visibly worried person looking at a plummeting stock chart displayed on a computer screen.

Image source: Getty Images.

This measure of investor sentiment has always been a great buy signal

While there are many metrics and gauges designed to measure how greedy or fearful investors are at any given time, a technical indicator might prove much more useful in identifying the best buying opportunities. Specifically, I’m talking about the percentage of S&P 500 stocks that are trading above their respective 200-day moving average.

Moving averages are an element of technical analysis that averages a company’s stock price over a set period of time. The assumption being that the moving averages will provide some level of support or resistance, depending on which side of the moving average line a stock is on.

But moving averages by themselves are not particularly useful. They tell us nothing about what makes a business work or what drives its future. Moving averages can, however, provide an accurate insight into investor sentiment.

Throughout history, investors have had a habit of pulling valuations too high during bull markets and becoming too pessimistic during bear markets. By looking at the percentage of S&P 500 stocks above their 200-day moving average and comparing that number to historical numbers, we can identify when investors have broken out of the upside or downside.

Currently, 37.6% of the roughly 500 companies that make up the S&P 500 are trading above their 200-day moving average. It’s not a particularly telling number one way or the other. However, since the start of 2002, there have been a dozen instances where the percentage of S&P 500 stocks above their 200-day moving average has fallen below 18%. Each of these cases represented an incredible buying opportunity.

But there’s a caveat to this investor sentiment indicator: it’s not for short-term traders. Just because investor sentiment is weak doesn’t mean it can’t get worse.

During the depths of the Great Recession in 2009, the percentage of S&P 500 stocks above their 200-day moving average only bottomed out at 1%! In other words, it is not an indicator that will tell you precisely when a bear market bottom will occur. Rather, it offers a successful track record of accurately predicting the approximate bottom of the most followed stock index by alerting investors to overly negative investor sentiment.

History is on the side of long-term investors

But this is not the only measure that can give investors a boost. Historically speaking, every major decline in the stock market has represented a surefire buying opportunity for long-term investors.

According to consultancy Yardeni Research, the S&P 500 has fallen at least 10% 39 times in the past 72 years. In short, stock market corrections, and even bear markets, are probably more common than you think. Yet in each of these cases (with the exception of the current bear market), a bull market rally ultimately recouped all that had been lost. In time, “this too shall pass” will prove true, once again.

Going further, data has shown that the S&P 500 has never let investors down if they’re willing to buy and hold a tracking index for 20 years. According to data published by market analyst Crestmont Research, the rolling 20-year total return, including dividends paid, for the S&P 500 since 1900 has never been negative. Put simply, this means that no matter when you bought an S&P 500 tracking index from the start of 1900, you came away richer as long as you held it for 20 years. That means now is as good a time as any for patient investors to put their money to work on Wall Street.

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