Time to Buy Stocks

by Chris Johnson and Jon Lewis 17/06/10

The market finished yesterday's trading flat as the Dow Jones Industrial Average (DJI) and the Nasdaq (NASD) finished the day up (by a frog's hair), and the S&P 500 (SPX) and Russell 2000 (RUT) closed lower (by the same margin).

The results were similar at the sector level, with five of the 10 major sectors finishing the day slightly higher. Sectors at either end of the spectrum were consumer discretionary (-0.6%), consumer staples (-0.5%) and energy (-0.2%), utilities (+0.6%), health care (+0.3%) and tech (+0.2%).

The trading day starts with four economic reports being released before the open. The reports are initial jobless claims (consensus 450,000), continuing jobless claims (consensus 447,500), consumer price index (consensus -0.1%) and core CPI (consensus +0.1%).

What the Markets Are Saying

A term that comes up often in technical analysis of the market is "inflection point". For whatever reason, this term has also become a buzz word over the last week with the politicians when referring to the efforts to contain the Gulf Coast oil spill. We thought that we would take a few moments to define the term for our technical purposes, especially since the market appears to be at an important technical inflection point.

According to the dictionary, an inflection point is defined as "a point on a curve at which the curvature changes from convex to concave or vice versa." In other words, a point at which a trend (curve) changes. According to this definition, there are a few technical inflection points that have occurred over the last week that should have investors turning bullish toward this market.

Most notably, the short-term trend in the S&P 500 should be on investor's radar. The chart below displays the SPX with its 10-day moving average. Of interest in this chart are the two distinct inflection points in the SPX's 10-day moving average. The previous inflection occurred in mid-February as buyers moved back into the market after a successful test of the SPX's 1,050 level.

More recently, the SPX is once again bouncing from this same technical level, prompting a reversal in the SPX's 10-day moving average. It is this reversal that has us in short-term bullish mode.

Now, it's easy to pull a chart of the SPX and identify a trend that worked the last time around, but we tend to avoid hanging our hats, or any investment dollars, on short-sighted results. Given that, we always check the historical performance of indicators like this to quantify their performance.

In the case of the 10-day inflection points of the SPX, the results are decidedly positive and reliable. Using our quantitative model for identifying a reversal in the SPX's 10-day moving average shows that since 1950, the market has rallied more than 1% over the following five trading days when these inflection points happen. The success rate of these signals registers an impressive 78%. Looking out further, the market averages 1.7% higher 71% of the time. That's more than double the "average" SPX performance since 1950. The table below details the average results.

Now, we could go further into the numbers and really bore you, but what's important is that the shift in the market's trend over the last week is something that is likely to gather steam, especially given the fact that many investors are now sitting on the sidelines. We'll go into the seasonality trend that is in place for stocks in tomorrow's Daily Market Outlook.

The bottom line is that you should be buying stocks as we head into the last few weeks of the quarter. We will run through the sectors that are showing these technical improvements tomorrow, as well as a short list of stocks that are following the same technical patterns and historical returns. Until then, happy trading.

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