History shows markets will bounce back:Deeply oversold levels a buying opportunt

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“History shows markets will bounce back: Deeply oversold levels a buying opportunity” by Jon and Don Vialoux
http://www.financialpost.com/per ... /5291875/story.html

Fear has dominated North American equity markets in recent weeks. The VIX Index, frequently called the Fear Index, spiked to as high at 48 percent on August 8th. Last Friday, it remained elevated at 45 percent.

Fear is understandable. Since July 8th the S&P 500 Index has dropped 17.1 percent, the Dow Jones Industrial Average has fallen 15.2 percent and the NASDAQ Composite has plunged 18.7 percent. Since July 22nd the TSX Composite Index has fallen 11.2 percent. Volatility in equity markets continued last week when the Dow Jones Industrial Average recorded gains or losses in excess of 400 points on four of five trading days. Where do North American equity markets go from here?

Warren Buffet famously said, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. Recently, Mr. Buffet confirmed that he has been a buyer of equities during the current period of weakness.

Technical indicators suggest that deeply oversold levels currently are providing a buying opportunity. Percent of TSX Composite stocks trading above their 50 day moving average has fallen below 10 percent on only five occasions since 2001. On each occasion, the TSX Composite recovered sharply during the next six to twelve weeks for an average gain per period of 16.5 percent. Percent of stocks trading above their 50 day moving average recently fell below the 10 percent level for the sixth time when it reached a low on August 8th at 6.92 percent. Percent subsequently recovered to 17.31 percent at the end of last week. Four of the five occasions since 2001 also occurred after the VIX Index peaked above 37 percent, a scenario that is repeating this time as well.

At the end of last week, North American equity indices were testing their August 8th lows. They are 1,101.54 for the S&P 500 Index, 10,604.07 for the Dow Jones Industrial Average and 11,617.81 for the TSX Composite Index. If the lows hold this week, equity markets are primed for a significant gain during the next six to twelve weeks.

Several events could impact equity markets during the next few weeks during a period when seasonal influences usually are negative. Thackray’s 2011 Investor’s Guide notes that September has been the worst performing month for the S&P 500 since 1950.

A potentially positive event is the Federal Reserve’s annual economic policy symposium in Jackson Hole, Wyoming from August 26th to August 28th Last year at the conference, Federal Reserve Chairman Ben Bernanke announce the start of the second quantitative easing (QE II) program. Equity markets moved strongly higher thereafter until February. Will Bernanke announce QE III at the conference this year? Bay Street and Wall Street have mixed opinions. Start of a QE III program initially will have a positive impact on North American equity markets if announced.

Potential negative events include the start of hurricane season that usually peaks in September and commemoration of the tenth anniversary of the terrorist attack on September 11th 2001. Security concerns will elevate early in September for fear of a retaliatory strike by Al-Qaeda following the demise of Bin Laden.

Preferred strategy during volatile, oversold markets is to own equities in sectors that already are showing strength relative to equity market indices. They include gold, agriculture, biotech and “gassy” energy stocks.