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The market is rallying now, but these indicators will show when the selling is really over


Trader on the floor of the New York Stock Exchange.

Lucas Jackson | Reuters

The market’s swift decline from record highs sparked by the coronavirus outbreak has left investors wondering when the bleeding will stop.

On Feb. 19, the S&P 500 hit an all-time high. Just a week later, the broad market average traded in a correction — down more than 10% from those levels. It was the fastest drop from an all-time high into correction levels for the S&P 500 on record.

Since then, stocks have tried to recover from the sell-off. The S&P 500 on Monday notched its biggest one-day gain since August 2011. The Dow Jones Industrial Average posted its biggest one-day point gain ever that day. However, strategists at RBC Capital Markets and Credit Suisse think some sentiment, technical and policy signals need to be triggered before a bottom can start forming.

“The S&P 500’s late-February drop was not accompanied by true capitulation by equity investors,” said Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets. “We haven’t yet seen signs of extreme bearishness among institutional investors or retail investors.”

In an investor note, Calvasina said sentiment among asset managers remains in “euphoric territory,” judging by positioning in U.S. equity futures that allow investors to buy and sell at specified targets.

She added that similar positioning took place ahead of the sell-offs in the summer of 2019 and early 2018. This, Calvasina said, is a “testament to how extreme bullishness had become,” suggesting a decline in positions that anticipate a rise in stocks is warranted for a meaningful market bottom to form.

Peak virus and peak sentiment

The strategist also advised clients to look at the American Association of Individual Investors sentiment survey, which tracks retail investors’ market outlook. She noted 39% of survey respondents were pessimistic about the six-month market performance as of the latest reading. However, Calvasina said bearish readings needed to range between 40% and 50% “before bearishness tops out.”

AAII sentiment survey readings have been used as contrarian indicators for years. In other words, when retail investors get too bearish, it becomes a buy signal for some investors.

Andrew Garthwaite, head of global equity strategy at Credit Suisse, said the number of new coronavirus cases needs to peak globally before the market can bottom.

“While lessons from the SARS outbreak of 2003 are becoming perhaps less relevant as this outbreak becomes very much more global, one key observation we think remains valid, that markets troughed when the rate of new infections peaked,” Garthwaite said in a note.

The number of confirmed coronavirus cases around the world has topped 93,000, according to data compiled by Johns Hopkins University. Global deaths numbered more than 3,000.

Garthwaite pointed out that new cases in China — the epicenter of the outbreak — have fallen since their initial surge. However, he added the number of cases outside of China, particularly in Europe, is on the rise.

Another signal that needs triggering before calling for a bottom, Garthwaite said, comes in the form of policy responses from fiscal and monetary institutions to stem the economic downturn from the coronavirus.

In the U.S., some of these measures are already being taken. On Wednesday, U.S. lawmakers struck a deal on more than $8 billion in emergency funding to combat the virus spread in the country. The Federal Reserve on Tuesday cut rates by 50 basis points.

China’s central bank has also taken measures to ease monetary conditions amid the outbreak.

“A supply side shock is much harder to address than a shock to demand, but we are now starting to see the first signs of a policy response from major central banks,” Garthwaite said. “Moreover, we are seeing some efforts to ease fiscal policy.”

—CNBC’s Michael Bloom contributed to this report.

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