By Michael Brush
Yes, it’s safe to buy this pullback in stocks. And if you got frightened Monday and sold, which was admittedly a scary day for many investors, get back in.
Here are three reasons why, followed by three stocks to consider.
1. Sentiment is very dark
Much of the stock world was in a bear market Monday. The Russell 2000 /zigman2/quotes/210598147/delayed RUT -1.56% was down more than 20% from recent highs, the definition of a bear. The Nasdaq /zigman2/quotes/210598365/realtime COMP -2.35% was just one percentage point away. The S&P 500 /zigman2/quotes/210599714/realtime SPX -0.81% held up better. It only slipped into a correction (down 10%).
This caused loads of pain. That’s no fun, but it tells us it’s a good time to buy, in the contrarian sense. According to this style of investing, you want to get bullish when the crowd is exceptionally bearish. That’s the case now.
For my stock letter Brush Up on Stocks (link in bio below), I track about 10 indicators to get a feel for sentiment. Here’s a summary of the bullish signal from three.
* The Investor’s Intelligence Bull/Bear ratio measures the sentiment of stock newsletter writers. I use this as a contrarian indicator. Lower means more bearishness by them, which is bullish. The indicator suggests the market begins to look attractive when this reading falls below 2. Stocks look extremely attractive when it falls to 1 or below. It came in at 1.59 last week, but it is definitely closer to 1 now. We’ll find out later this week, when this indicator gets updated.
* The Chicago Board Options Exchange’s CBOE Volatility Index /zigman2/quotes/210598281/delayed VIX +3.41% is a popular fear gauge because it measures expected volatility. Higher levels mean more fear. It begins to show exaggerated bearishness (which is bullish in the contrarian sense) above 25. Bottoms are often marked by spikes up into the 30-40 range. It traded near 39 on Monday.
* The American Association of Individual Investors (AAII) conducts a weekly sentiment survey of investors. When this gauge is extremely bearish, it’s time to buy. That is the case now. This signal triggers a buy signal when the percentage of bulls minus the percentage of bears falls to -10, on a four-week moving average basis. We are close. The latest readings came in at 21% bullish vs. 46.7% bearish for a one-off reading of -25.7. The four-week moving average is -8.15.
This chart, courtesy of Charles Schwab /zigman2/quotes/201281754/composite SCHW -2.04% chief investment strategist Liz Ann Sonders, shows just how extreme the current negative signal is (which is bullish!).
The bottom line : Investor sentiment is significantly dark, which suggests we are near a market bottom.
2. Insiders aren’t steering us away from stocks
Insiders are now on lockdown because of earnings season. So, their buy/sell ratio is a little less meaningful. But we can still track this ratio because some insiders remain active.
Insiders aren’t actually bullish at the moment. But they aren’t cautious, either. They’re neutral, according to Vickers Insider Weekly, published by Argus.
I’d rather see them bullish. But anecdotally, I can tell you that on particularly sharp down days, insiders have been stepping up to buy, including in emerging tech and cyclical areas like industrials, chemicals and real estate. They are buying economically sensitive names — not defensive stocks like consumer staples — which brings us to the point #3, next.
The bottom line : Insiders aren’t bearish.
3. The economy will be fine
A key part of my belief that this is a time to get bullish is that the economy is not going into recession, and the Federal Reserve will not push it there.
Can the economy really survive Fed interest rate hikes and tapering? I think so, because there are so many embedded sources of stimulus in the economy, as outlined by strategist and economist James Paulsen at Leuthold.
They include: The home-buying binge (those houses need to be filled with stuff and many can stand some remodeling projects). Strong consumer balance sheets and income levels that support consumer spending. Low consumer sentiment, which tells us there is lots of room to improve as Covid eases. Corporate balance sheets are strong. And there’s an inventory buildup phase ahead because those levels are low due to supply-chain snags.