This past week marked the 30 year anniversary of Black Monday. There was a lot of talk in financial media about the similarities between this year, 1987, and the market’s behavior leading up to Black Monday. Naturally, the aim was to scare investors into “wanting more” news. In the end, the anniversary came, went, and now it’s behind us with very little in the realm of similarities.
I typically like to buy stocks and stock ETFs the market is in a longer-term uptrend, while on a near-term pullback or “sale.” Normally, these opportunities occur every six weeks or so, but the last time one of these pullbacks took place was in early August, which tells me two things right off the bat:
- The market has been on a great run, and
- It’s ripe for a pullback or correction
Before we go any further, it’s important to define these two terms. A pullback is defined as a drop in value around -5%, give or take a percent or two. A correction is defined as a drop in market value between -10 – 20%. Both of these behaviors are completely normal!
In fact, the stock market experiences roughly three pullbacks each year, on average. Further, if you go all the way back to The Great Depression, the market experiences a correction of roughly -11% about once per year. Most investors don’t realize these short term pullbacks and corrections occur because they’re busy with their families, putting energy into their careers, or the drops in value are so short-lived, they don’t even notice the impact on their retirement assets before the portfolio has mostly recovered.
Bottom line, as stocks have been ripping higher for almost 12 straight months since the election, the market is ripe for a pullback at minimum – or even a correction.
As you can see in the top section of the chart below, the short, intermediate, and long-term trends (in red, blue, and gray) are all sloping upward, which indicates a healthy bull market. Only the ultra-short trendline (in black) is curling over, but trends as short as these should only be used for short-term buying or selling opportunities, not for long-term investing.
If you look above in the middle section of the chart (labeled PMO at the left), we’re starting to see momentum slow down and it looks likely we’ll see a trend change in the future. I drew vertical lines in blue (for positive trend changes) and red dotted lines (for negative ones) whenever the PMO momentum indicator changes for the positive or negative. You can see at the far right where I’ve drawn an arrow that signs are pointing to a potential pullback in price in the near future, which would create a great buying opportunity to add more money to the market (since we’re in a long-term uptrend).
Lastly, the bottom section of the chart above represents RSI (Relative Strength Index), which is a different type of momentum indicator. When this metric is above 70, it tells us two things:
- The market is strong and healthy, but
- It’s also “overbought” or in other words, overextended, long-in-the-tooth, or expensive in the very near-term.
So in conclusion, the market looks very healthy on all long-term fronts and I expect we’ll continue to see higher values over the course of the next six months or so. However, in the short-term, I believe it’s highly possible we could see a pullback or correction in prices, which would not be scary or worrisome at this juncture – rather, it would be an opportunity to take cash off the sidelines and buy more while the market is “on sale.”
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