The Castle Walls Are Breached. What’s Next?

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Late last week, the S&P 500 did something it hasn’t done in over 6 months.

The index pierced below its 200-day moving average.

This is a critical level that many technical analysts watch to size up the overall trend. It’s also an event that triggers the media to release fear-driven headlines.

One such article reads how “analysts warn of disappointing returns” should the market breach this zone. Another states how “nothing good happens” after stocks drop below this line.

It feels like an invading army breaking through the castle gates. Like chaos is right around the corner.

But rather than accepting the “doom loop” as fact… I did a study to see how accurate these market death threats are.

Before you strap on your crash helmet, you’ll want to review the evidence…

Today we’ll take a journey through history, revealing if these worries have merit. But first, let’s recap where we stand now.

Bank Blowups, Inflation, COVID, and Now…

Understanding the market trend is step one for anyone serious about investing.

Uptrends signal that money is flowing into stocks. Downtrends, like we’re in now, suggest outflows.

That’s been the theme from August, pushing stocks into deeply oversold territory.

On Friday, the S&P 500 broke below arguably the most widely followed key level, the 200-day moving average. This line in the sand equates to 4247 at the index level, exactly where we are as I write this Wednesday morning. Here’s the chart.


Source: FactSet
You’ll notice:

1. Friday was the first close below this level in over 6 months
2. At 4247, the S&P 500 is back at levels last seen in early June

At first glance, this barrier may make you feel queasy. Lower prices often elicit pain and discomfort.

However, it shouldn’t. It’s not uncommon for stocks to fall below this line.

To prove this, let’s revisit recent history. The following chart notes each instance where the market initially dipped below the 200-day moving average, singling out periods when at least the prior month closed above the line.

Over the past 5 years, there’ve been 5 instances of a fresh break below the 200-day moving average:


Source: FactSet
Looking above, these selloffs occur during some of the most memorable periods for investors.

They include:

• March 2023 — regional banking crisis
• January 2022 — runaway inflation
• February 2020 — COVID-19

Based on these scary moments, you may be thinking you’ll sit this one out. But history says that would be a missed opportunity.

The Most Trying Times Are Buying Times

At TradeSmith, we use analytics and historical evidence to guide our investing path.

Instead of opining on what may happen, let’s put the worries aside and study the proof.

For this study, I went back 30 years and tested how the S&P 500 performs after an initial breach below the 200-day moving average, breaking a streak of trading above it.

Singling out periods with fresh plunges below the line are the closest events that echo today’s situation. Including last Friday, it’s occurred 32 times…roughly once a year.

The reality is this: The most trying times are buying times.

After a new break below the 200-day moving average:

• The S&P 500 gains an average of 3.5% three months later…
• Six months later, you’re looking at double the performance with a 7% lift
• Twelve months later hands you average gains of 10%, with 3 out of 4 odds that stocks are higher.

Check it out:


That’s a lot of green if you ask me.

The fear-inducing media deluge of pain ahead doesn’t hold water based on the facts.

That’s why I suggest you rely on data for your guide.

While the 200-day moving average is important to track, today’s study is a reminder that stocks are on sale. That means, get your buy list out.

Take the crowd’s pain as your gain. And do it with Quantum Edge Pro.

My business partner, Jason Bodner, thinks the continued slide in stock prices today will look like the world’s most obvious buying opportunity in hindsight. That’s why he’s been busy sharing the top picks on his buy list with his subscribers.

He targets well-capitalized and growing firms on the smaller end of the market cap spectrum, using his proprietary market-scanning tool and Quantum Edge score to find the best opportunities.

With Quantum Edge Pro, he aims to uncover the big stock stories that will dominate the next bull run.

As stocks get more oversold by the day, the perfect moment to buy Jason’s picks could be mere hours from now.

Regards,

Lucas Downey,
Contributing Editor, TradeSmith Daily