ROAD - SPY: The S&P 500 Is Still 'Double-Barreled' Oversold (With One Exception)

2023-10-31 13:59:55 ET

Summary

• "Double-barreled" oversold reading predicts higher returns in the S&P 500 240 days later, with an average return of 29%.
• Short-term performance following the signal is solid but not as strong, with a win rate of 81%.
• The double-barreled signal had a falsely bullish signal in early 2008, but overall has a 91% win rate.

We wrote last week that we got a "double-barreled" oversold reading on our overbought/oversold indicators: The percentage of stocks trading over 5% above the 200-day moving average and the average score in our custom 1,600 stock universe.

Historically, this has been an excellent predictor of forward returns.

Over the past decade, there have been 22 "double-barreled' signals. The SPDR® S&P 500 ETF Trust ( SPY ) finished higher 240 days later 100% of the time, generating an average and median 29% and 27% return.

The short-term performance is solid, but not nearly as strong.

Double-barreled readings can continue for multiple weeks as stocks find their bottom, such as in 2018 and 2020. As a result, the 20-day win-rate following this signal falls to 81%.

This suggests that dollar-cost averaging during the entire period that we're flashing a "double-barreled" signal is best, allowing you to average your cost without having to perfectly pick the low.

An exception to the double-barreled signal's stellar return

Our last article sparked comments that correctly point out that the double-barreled track record is relatively short.

Despite including tough periods, such as in 2018 and 2020, data back to 2014 does not reflect what could happen during a period of an extended recession, such as 2008.

This week, we went back to our source data and retrieved historical data previously archived (the model was the same, however, the data was compiled and presented in different formats).

What we discovered was that the signal remains robust, but it did throw a falsely bullish signal in early 2008.

Specifically, since February 2005 when the data set starts, there have been 66 double-barreled signals. The S&P 500 was higher 240 trading days later in 60 instances. The six exceptions were all from early 2008, when double-barreled signals flashed six times from 1/15/2008 through 3/18/2008. Stocks didn't bottom until the following March, so 240-day returns were negative for those six signals.

Otherwise, the double-barreled signal has a 100% track record for upside 240 days later. However, including those six false alarms, the win rate slips to 91%.

Whether the double-barreled signal works again may depend on whether this is an early warning of a steep recession similar to the Great Recession. I'll leave that debate for another post, but feel free to share your thoughts in the comments.

Regardless, as we wrote last week, double-barreled signals can cluster and last for weeks, so dollar-cost averaging is wise. It could allow you to lower your average cost without having to be perfect in timing the low perfectly.

What should you buy?

First, here's the complete data with returns using the S&P 500 SPY adjusted closing prices as proxy.

Weekly, we rank every stock in our custom 1,600 stock universe across 7 factors associated with stock price returns. The factors can be viewed here . In short, they cut across technical and fundamental, including earnings beats history, forward earnings, relative valuation, money flows, and other market moving data points.

Once we've scored each stock, we aggregate those scores by sector and industry and then, rank them so members can see the 'best ponds to fish in' for new ideas. Once that's done, we break the universe into large, mid, and small cap, providing the highest rated stocks in each of the highest rated industries and sectors.

What does the model suggest buying today? The large-cap ranking is most representative of the S&P 500 (SP500) and NASDAQ 100 (NDX), so let's focus on that for now.

You'll see in the following table that the best large cap sectors including energy, industrials, technology, and services. ETF investors should therefore consider buying the Energy Select Sector SPDR® Fund ETF SPDR ( XLE ), Industrial Select Sector SPDR® Fund ETF ( XLI ), Technology Select Sector SPDR® Fund ETF ( XLK ), and Consumer Discretionary Select Sector SPDR® Fund ETF ( XLY ).

Individual stock investors can consider stocks within those baskets that are on watch lists, or consult our most recent large, mid, and small cap rankings for new ideas.

The industry ranking also provides insight into what to buy during the sell off. The following table shows all the best industry ranks for our large cap, mid cap, and small cap universes, including the highest scoring stocks in each of them. ETF investors can consider the relevant ETFs where applicable, while individual stock investors can consult our rankings for more ideas.

The best large-cap industries are apparel retail ( TJX , LULU ), oil & gas equipment & services ( SLB ), specialty business services ( CTAS , CPRT ), staffing & employment services, and insurance brokers ( AJG , BRO ).

The best mid cap industries are rental & leasing services ( R ), oil & gas E&P ( MTDR , SM , MRO , CTRA ), home healthcare, electronic components ( JBL , FN ), and telecom services ( TDS ).

The highest-rated small cap industries are education & training ( UTI , STRA ), engineering & construction ( STRL , ROAD ), oil & gas equipment & services ( GIFI ), retail REITs ( SKT , RPT ), and semi equipment ( CAMT , ACMR ).

In all of these cases, remember that while buying double-barreled signals historically pays off, readings can persist for a bit. Therefore, pick your entries, use starter positions, dollar-cost average, and use stop losses to control risk where appropriate.

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