Dip Buyers Fading Extreme Stock Moves Have History on Their Side

(Bloomberg) -- Traders around the world inspecting the Monday market carnage like what they see right now.

The worst sell-off since the global financial crisis was followed by furious buying in Tuesday trading. U.S. futures rose the most allowed after stock activity was halted just a day earlier, while European shares at one point headed for their sharpest rally since 2015. The S&P 500 index surged around 3.4% at the open.

Dip buyers are resurfacing on signs markets had turned so bearish they now offer a tidy premium for those venturing back. With President Donald Trump mulling tax cuts and relief for industries acutely affected by the coronavirus outbreak, market pros are touting the case for a tactical rebound.

That’s even as wild markets scream snowballing recession risk, the number of virus cases in Europe and America looks poised to jump -- and the White House sends mixed signals on the timing of fiscal stimulus.

“We are far from out of the woods, but if federal stimulus efforts are to be successful, the market is attractive,” Evercore ISI strategists led by Dennis Debusschere wrote in a note.

There are plenty of signs of extreme bearishness that in the past have reliably paved the way for a rebound.

As of Monday close, more than half of the stocks on the S&P 500 were oversold, according to the 14-day Relative Strength Index, a condition that has never lasted for longer than three days since the global financial crisis. Almost every stock on the S&P 500 traded below their 10-day average. As bond yields collapse, shares are looking the most attractive versus debt since 2012 by one measure.

In most cases starting from the Great Depression, buying equities after a 20% plunge in the S&P 500 -- the benchmark fell 19% from its peak -- has typically delivered decent returns, according to analysis by SentimentTrader.

A Cboe measure of the ratio between bearish and bullish positions in the options market also spiked to the highest since late 2018 -- when shares bottomed out before a spirited new-year rebound.

“Technical indicators are now flashing a high probability of a short-term rebound in U.S. equities,” BCA Research analysts Mathieu Savary and Aneel Samra wrote in a note. “It is too early to say if any upcoming rebound will represent the ultimate end of the selling.”

If the technical stars are aligned for a short-term bounce, China’s example may offer firmer grounds for optimism. Large-caps there have jumped nearly 11% from their bottom as the virus outbreak slows and government support ramps up. That’s a sign risk appetite can bounce back as sharply as it shrank, and suggests Chinese economic activity is starting to recover.

Of course, financial markets reflect new information much faster than economic data. With Italy attempting a nationwide lockdown and cases in Spain and the U.S. jumping, the impact on growth looks set to only widen.

Bloomberg Economics’ model, which uses both economic and markets data as inputs, is projecting 53% odds of a U.S. downturn over the coming year, the highest since after the global financial crisis.

But there’s a case traders have turned excessively pessimistic. Interest rates have been pricing in a 95% chance of a typical recession, high-grade credit 90% and equities 73%, according to JPMorgan Chase & Co.

Michael Strobaek, global chief investment officer at Credit Suisse Group AG, expects authorities in Europe and the U.S. to contain the outbreak and stave off recession. That would pave the way for stock-market confidence to build over the next three months onwards, he wrote in a note.

“Attention should then shift back to fundamentals such as equities’ attractive dividend yield, especially compared to sharply fallen bond yields,” Strobaek said.

To contact the reporter on this story: Justina Lee in London at jlee1489@bloomberg.net

To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Sid Verma

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