Studying Action Beneath Markets Surface During A Correction Will Set You Up For Success Once Market Pressures Subside.
I’ve been closely following the markets for over 25 years now with my largest stretch taking place while working with top fund managers around the world. That is to say, I’ve seen my fair share of boom and bust cycles and while the current market correction has given us the most volatile month (February) since 2008, there are underlying dynamics taking place that can historically point you to the next cycle’s winners.
As stated in my most recent article here, the markets are currently recovering from a correction – defined as a decline of 10% from peak in price but no more than 20%. Corrections occur in the markets rather frequently and oftentimes are a way for excesses to be corrected and for the markets to reset.
The September 2017 to late January 2018 runup is a prime example of an excess as this 5-month period resulted in a 13.5% gain for the S&P 500 with the exuberance in January accounting for 5.6% of that advance. With valuations stretched above average, a fear induced uptick in bond yields caused a swift tumble in the broader markets this February with the Dow dropping 12% in 2 weeks.
A majority of the trading days in February saw intraday swings above 1% with several days being well above that. With no sector left unscathed, February’s wild swings shook investors as fear-induced selling overtook tepid buying on the weakness.
Despite all of this whipping around, there were underlying Industry Groups that were quietly ignoring all of the chaos. These groups and several of the stocks within them either dropped only slightly or actually ticked up despite the heavy distribution going on around.
This ability of the stock to shrug off heavy selling is very important to pay attention to as historically during a correction or bear market, those stocks that are able to withstand the downward pressure of the broader markets go on to become your leading groups/stocks once the market pressures are released.
Let’s take a look at the recovery period from the most recent correction that takes us back to Nov 15, 2015 - Feb. 15, 2016. This 3-month period saw a loss of 13% and while most areas of the market were getting battered, there was one non-defensive group that didn’t go down quite as much. Not only that, this Sector recovered* before the broader markets.
The Sector I’m referring to is Technology (using XLK) and within this large sector many individual stocks that were able to post gains while the broader markets came under strong distribution went on to great gains once the market pressures subsided.
We’re talking Tech stocks such as Nvidia (NVDA) (+233%) and Applied Materials (AMAT) (+65%) as compared to the S&P 500 which was up 11% post recovery. In addition to outpacing the broader markets during the recovery, these stocks had one other common characteristic that is critical. That is, they both reported strong earnings and sales that were well ahead of estimates during the corrective phase.
Let’s turn to the current market conditions and you’ll see that Technology stocks are once again holding up well in a recently damaged market. In addition, this sector has appeared to recover* from the correction while the S&P500 and Dow Jones Industrial Average still have more work ahead of them.
There are distinct sub-groups within Technology that are clearly setting themselves up to be leaders once the rest of the markets resume their bullish uptrend and those subscribers to my MEM Edge Report have been alerted to them over the last 4 weeks.
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*For my work, a recovery is defined as a sustained break back above key moving averages on volume and ideally, coupled with a break back to new highs.
Mary Ellen McGonagle
MEM Investment Research