Substantial Nasdaq Rally Ahead?

Sometimes, we have to hit a new low point before we can go on to bigger and better things…

For me, that moment came in January 2001 - I was “stuck” in a good job that I hated, my beloved father-in-law had just passed away, and my wife and I lost our baby son after 18 days of struggle due to prematurity.

While it seemed impossible at the time, the darkness did eventually lift. In life we all go through these cycles of scraping along at the bottom, then rising to new heights. Just like life, markets do the same.

So the new lows that we’re seeing now in some stock sectors might not be the beginning of the end, but rather the necessary purging that needs to be done before we're able to rise again.

It always seems impossible and counter-intuitive at the time, but as I’ll show, the market hitting a new low is sometimes precisely the event that triggers a new leg up. In fact, the only four times these new-low conditions have existed in the past, the Nasdaq rose by 58%, 7%, 33%, and 68% twelve months later. Let me explain…

It's been over three yearssince the Nasdaq Composite suffered the indignity of being listed in the "new low" column of my local paper. That's quite a streak, and over the 35-year history of the index, something rarely matched.

But it was just matched… So let’s take a quick look at what happened the four other times in its history that it went at least three years without hitting a new 52-week low:

First, 1980. The Composite had managed to last 1,384 days without hitting a new 52-week low, but on March 26, 1980, it did just that.

The odd thing is that despite all the hand-wringing about the first new low in over five years, the index bottomed the very next day and went on a fantastic run, tacking on another 58% one year later.

Fast forward to 1987. The market had been on another great run (lasting 818 days without hitting a new low), but then it dropped dramatically leading up to Black Monday. On that day, the Composite eclipsed its low from the previous December.

Some hall-of-fame traders like Paul Tudor Jones were able to navigate the terror and profited handsomely, but most panicked in the days ahead and drove the index down temporarily. It took another 7 days before the Composite hit its low, but from the close on Black Monday, was still able to record a nearly 7% return over the next year.

Now let's skip ahead another seven years to 1994. On June 23rd, the Nasdaq fell below the April lows (that traders had thought was THE low), and set a new 52-week low in the process for the first time in 932 days.

Once again, the new low proved to be a point to not panic, as the Comp formed its low the very next trading day, and jumped over 30% in the course of the following year.

For our last precedent, we're going to visit 1998.  This time the Composite lasted 1,056 days without seeing a 52-week low, but that ended on August 28th in the midst of trouble in Russia.

Curiously,the index was able to form a low the next trading day. It soared 17% over the next month before another gut-wrenching short-term haircut, but from the date of the new low on the 28th, it ran 68% over the following year.

It's always tough to put a lot of faith in just four historical precedents. The reason I bring them up is due to the intriguing consistency in when the Composite formed a low. All of them were significant in that we had gone at least three years before seeing a new 52-week low, and at the time of the low, we can just imagine what traders were thinking. Surely, “the bull market is dead” was on nearly every one of their lips. And that’s when you want to be a buyer.

You want to buy when we’ve had major “washouts” in the market. We’re now seeing new 52-week lows in the Nasdaq for the first time in three years. Another of my “washout” indicators is flashing as well…

On Friday only 6% of the components in the Nasdaq 100 (NDX) closed above their respective 10-day average, and only 10% closed above their 50-day. That's a special kind of washout, and it's been rare to see over the past decade. In the nine times this decade we’ve seen such washouts, the NDX was higher three months later, and by an average of over 30%.

Obviously, the developments in the Middle East could hold great sway in how eager traders are going to be to put capital at risk. With what looks like an impending war, and an earnings barrage starting mid-week, stock should be in for a volatile week.

But looking farther out, the conditions are in place for a substantial rally. A further move to new lows now (if it happens) should prove to be temporary when looking out over the next few weeks to months.

So for the first time this year, starting right now, we’re buying stocks. Like I said at the beginning, it seems impossible to contemplate a rally now… and it seems counterintuitive to buy right now. But history shows us that buying when nobody else is willing to is the right thing to do…

Now is one of those times.

Good investing,

Jason Goepfert, 
for DailyWealth

Editor’s Note: If you’re not familiar with the work Jason Geopfert does over at sentimenTrader.com, you really should check it out.

With original commentary and easy-to-read charts, Jason gives some of the most thorough analysis of market sentiment you can find anywhere.DailyWealth is a paid up subscriber… and frequent reader.