If you look at the bullish phase the market has been in over the last 20 months, there have been few great buying opportunities. Some would argue that the bullish phase goes all the way back to 2009 and for long-term investors that like to buy on dips, the monthly charts have provided very few dips in the oscillators. Even the weekly chart shows few situations where the stochastic readings were in oversold territory.
Look at the weekly chart of the S&P 500 going back over the last six years. There are only three instances where the stochastic readings reached the 20 level which is the traditional signal for oversold levels. You can also see that the current readings aren’t even close yet.
It is also worth noting that the S&P went from May ’12 until January ’16 without seeing a single oversold reading. The S&P isn’t the only index like this either. The Nasdaq Composite has also had three oversold readings over the last six years, the Dow has had five instances and the Russell 2000 has had five instances.
We can also see from three sector ETFs that buying opportunities for those that like to buy on dips have been few and far between on the sector funds. The Consumer Discretionary Select Sector SPDR saw three opportunities, the Industrial Select Sector SPDR saw four opportunities, and the Technology Select Sector SPDR saw three.
It remains to be seen whether the recent increase in volatility will cause the indices or the sectors to reach oversold territory based on the weekly slow stochastic readings. It also remains to be seen as to whether or not it is a buying opportunity or the beginning of a bearish phase.
One factor that will likely determine whether it is a buying opportunity or the beginning of a bearish phase is the sentiment toward the overall market. There are several indicators that are hitting levels not seen since 2000 or 2007, the two periods when the last two bear markets started.
One indicator that is causing alarm is the margin debt level. Margin debt is at an all-time high and it eclipsed the $500 billion mark for the first time ever back in April. According to a recent article from Business Insider, even when you include an adjustment for inflation, the last two peaks were in early 2000 and mid-2007.
The second indicator that is causing reason for concern is the Allocation Survey from the American Association of Individual Investors. This is a survey of smaller investors rather than large institutional investors. In July, the cash allocation dropped to 14.5 percent and that is the lowest reading since January 2000. It is only the tenth reading below 15 percent since the survey started in November 1987. The average cash allocation over the last 30 years has been 23.4 percent.
There are other indicators that are flashing warning signs as well—the Investors Intelligence Bull/Bear ratio, Consumer Confidence, etc., but the two mentioned above caught our eye.
If the volatility continues and we see the stochastic readings dip down to oversold levels, it might be worth adding to your equity allocation, but it would be wise to check on the sentiment to see if any pessimism as entered the picture. If the optimism remains elevated at the time, it could mean that we are indeed entering a bearish phase.