A few nights ago I found something “strange”…
I was looking through some charts of the stock market going back several years and decades back to the 1990s.
I find this exercise both relaxing and stimulating as it trains my brain to spot patterns that repeat themselves. Spotting reliable patterns also means spotting potential opportunities.
During one such exercise, I found a chart which suddenly made me stop… I took a closer look and then I found an “odd” pattern.
I was looking at a chart of one of my favourite indexes for measuring “overbought” and “oversold” conditions in the stock market: the Bullish Percent Index (see chart below).
The Bullish Percent Index generates reliable “buy signals” for stocks when it falls below the 50% and the 25% line.
Take a look at this chart of the Bullish Percent index from 1997 to 2013, and see if you can spot the same recurring pattern that I saw:
You will notice that every year since 1997 the bullish percent index has tested or come very close to the 50% level (shown in red).
Every year EXCEPT 2013…
Now, you may think “so what?”.
Well, the fact is that every time that the bullish percent index has tested the 50% level, this has also coincided with a significant correction or sell-off in stocks.
Take a look at this chart of the S&P 500 from 1997 to 2013:
Every major drop that you see occurring in the stock market each year has coincided with a fall in the bullish percent index to test its 50% level.
Of course, during the bear markets of 2001-2003, and 2008-2009 the bullish percent index went BELOW 15%. However, these mammoth size crashes are normally buy opportunities.
Notice that although in 2005 we had a sell-off in the spring of that year, the bullish percent index did not exactly “touch” its 50% level. However, it came extremely close.
The only exception to this 16-year pattern is this year, 2013…
So far this year we have not yet tested the 50% level – not even once! (see below chart):
The black line (above) is the bullish percent index which is superimposed over the S&P 500 (grey line). The last time we tested the 50% level was May/June 2012. The stock market had a 10% correction back then, and that also was a great buy opportunity.
So if this pattern repeats – and that is an IF – then we should expect to see another significant correction in the stock markets between now and December.
Perhaps the “debt ceiling” this October could be a trigger. Who knows?
Now I will admit to you 3 things:
Firstly, the evidence going back only 16 years is pretty slim. I don’t have charts of the bullish percent index past 1997. However, I still think that a 16-year recurring pattern is worth paying attention to.
Secondly, you could also argue that because stocks are in a “bubble”, we should not expect a big correction this year. But I would disagree. Notice that during the 2 biggest bubbles of the last 16 years (the dot-com and the housing bubble) we still tested the 50% level.
Finally and importantly:
November to May has historically been a positive and bullish period for stocks. So if we are going to see any major sell-off this year, it should be soon and BEFORE the end of November…
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Alessio Rastani is a stock market trader at www.LeadingTrader.com