Following another late day selloff, the S&P 500 closed within one point of its 2008 low at 850. This is the third time the index has visited this support level in just over a month. We have been writing that a bottoming process has been underway, and that S&P 840 had strong potential as a short term low for the market (for the Dow Jones Industrial Average, the support level is 7,882).
Many of the classic signs of market bottoms are present today. For example, fewer and fewer stocks have reached new lows during the recent retests of the low. On October 10th, the first time the S&P traded down to 840, over 90% of stocks traded that day made new yearly lows (2,900 stocks), and downside volume exceeded upside volume by a 16 to 1 margin. Then on the November 13th retest, only 776 stocks made new yearly lows. Today’s retest? Only 82 stocks made a new yearly low. This positive divergence suggests the selling pressure is being exhausted.
Much of the breathtaking decline we have seen since August has been attributed to massive forced liquidation of mutual funds and hedge funds. Data released over the weekend shed more light on just how substantial the flight from equities has been in the hedge fund world. According to Bloomberg, 38 hedge fund managers with over $1 billion in assets under management reported that selling and market declines cut the value of their equity holdings by 30% in the third quarter to $273 billion. Several large managers cut their equity exposure by nearly 90% to raise cash for anticipated redemptions.
All of this cash will eventually find its way back into the market, fueling a strong rally. With stocks off 45% from the high just 13 months ago, and nothing but awful economic news all around us, the market needs a catalyst to break the downtrend and entice some of that cash to come off the sidelines. If the market is able to hold today’s low, equities will be set for a relief rally that could take the S&P 500 to near 1,000.
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