A Technical Take on Whether Stocks Can Hold the Line | Lord Abbett
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Equity Perspectives

The Russell 3000 Index recently crossed a key technical threshold. A sustained period above that level might signal continued strength in equities.

Read time: 6 minutes
 

Moving averages are not only important in helping to identify trends in stock and index prices, but they are also critical in determining support and resistance levels—the downward and upward levels, respectively, at which price movements may pause or reverse trend.  Our studies have shown that it is important to “respect where the price of the market is trading” in relation to its moving averages, particularly the 150-day moving average (MA).

Figure 1 gives a clearer view of the concept. The top panel takes us through three key instances in the past 15 years in which the Russell 3000® Index has broken above its 150-day MA: during the 2008–09 global financial crisis, the market volatility of 2015-16, and, more recently, the disruptions caused by the COVID-19 pandemic.

The bottom panel on the chart is also important. It is a measure of market participation aka market breadth. It shows the percentage of stocks in the Russell 3000 index that are above their 150-day moving averages.

 

Figure 1.  Three Key Technical Moves of the Past Two Decades
Price and 150-day moving average (top) and percentage of index stocks trading above their 150-day moving average (bottom) for the Russell 3000 Index, June 3, 2005-June 4, 2020

Source: FactSet. Data as of June 4, 2020. A moving average (MA) is a technique often used in technical analysis (see below) that smooths price histories by averaging daily prices over some period of time. The percentage of stocks in a given benchmark trading above or below a selected moving average is a common measure of market breadth, or how many stocks are taking part in a given move in an index or on a stock exchange.
The information shown is for illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

 

What do we see as the key lessons from the three episodes?

  1. Global financial crisis (2008–09): The market went back above resistance briefly early in the correction (resistance areas are roughly shown with vertical red lines). Often the first attempt to break through resistance can lead to a “fake out”; echoing the classic Toto song from a few decades back, the Russell 3000 was not able to “hold the line.” You can also see that market breadth was falling during this time. Market leadership was dropping like flies and so were many 401(k) balances.
  2. 2015–2016 Correction: There were two attempts to take back and hold the line (this is the most common pattern). The first attempt failed as participation rate was good, but not great. The second rally was able to hold the line and the participation rate shot up. The market then was able to turn the resistance line into a support line and went on a tear.
  3. COVID-19 Crisis: This obviously remains a question mark. We think we’ve made it through the worst of the crisis, but unknowns remain. The participation rate, although improved, is not as strong as we would like to see.

These episodes point to the importance of support and resistance levels mentioned earlier. Support and resistance lines often coincide with important price levels that mirror human emotions (i.e., greed and fear) in chart form. Often they are at previous prices where a lot of investors bought toward the end of a market rally (greed). These levels, after a correction, represent breakeven points for those that held on during the market correction. But “love isn’t always on time” as our Toto tune reminds us, so when the price gets back to those levels investors dump their stocks (fear) in order to break even. Markets tend to go sideways, or consolidate, around these key price areas until confidence can build to break through and hold the line. This helps turn those levels from resistance to support now that everyone has broken even or is now making money if they bought at the right time.

Once we’ve held the line and established an area of support to move higher from, it will be important to monitor not only price action, but fundamental information. Will corporate earnings come through better than expected (or better than feared in the case we find ourselves in now) by a sufficient degree to support the move in price? Or will a setback such as a renewed virus outbreak lead to the market falling back below the line and starting the process all over again?

While it is impossible to know how it plays out, we think having an objective process that includes simple, yet effective rules will allow us to dynamically and swiftly react to whatever the market brings our way.  In toto, we believe that there are enough signs from a technical standpoint that after their breach of the 150-day MA marker, stocks may not only “hold the line” but could potentially use that accomplishment as a supportive launch pad for additional gains in the years to come.

We believe combining fundamental and technical analysis is central to our efforts to generate returns—and manage risk—in select equity portfolios. We will continue to provide updates each month to help equity investors make sense of current technical trends, and the opportunities they may present.

 

A Note about Risk:  The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

Glossary of Terms

Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.

breakeven point defines when an investment will generate a positive return.

Market breadth or market participation refers to how many stocks are taking part in a given move in an index or on a stock exchange. One common measure of market breadth is the percentage of stocks in a given benchmark trading above or below a selected moving average (see below).

moving average is a technique often used in technical analysis that smooths price histories by averaging daily prices over some period of time. 

Technical analysts use support and resistance levels to identify price points on a chart where the probabilities favor a pause or reversal of a prevailing trend. Support occurs where a downtrend is expected to pause due to a concentration of demand. Resistance occurs where an uptrend is expected to pause temporarily, due to a concentration of supply. 

The Russell 3000® Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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