Once the stock market catches a break and trends up enough, we’ll probably see short covering keep it going for a while.

The percent of stocks trading above their 50 and 200 day averages is a useful signal of market breadth to gauge the participation in uptrends and downtrends.

I’ve been monitoring these statistical measures of trend and momentum for more than two decades, and long concluded after most stock prices have already trended up, I start to wonder where the next demand will come from to keep the uptrend going.

After prices have already fallen to an extremely low level, it starts to signal those who want to sell may have already sold.

But, it takes falling prices to drive the downtrend to a low enough point to attract long-term value investors as stock prices get cheaper and cheaper, to them.

At this point, below is the percent of S&P 500 stocks trading above their past 200-day average. We see only about 19% of the stocks in the S&P 500 are in intermediate-term to longer-term uptrends.

Can it get worse? Can stocks trend lower? and more stocks trend lower?

Yes, it can.

A visual of the same chart above in logarithmic scale helps to highlight the lower end of the range.

In October and November 2008 only 7% of stocks were in uptrends.

In March 2020 only 10% of the S&P 500 stocks were in uptrends.

Keeping in mind the stock index has some exposure to sectors considered to be defensive like utilities, REITs, and consumer staples, it took a serious waterfall decline like -56% in 2008 to shift most of the 500 stocks into downtrends.

The point now is, that about 80% of stocks in the S&P 500 index are already in downtrends and at some point, the selling will dry up and new buying demand will take over.

I’m seeing other evidence that correlates with these price trends.

According to the investment bank Deutsche Bank, there’s a record short in equity futures positioning of asset managers. That means investment managers have high short exposure, hoping to profit from falling prices, or at least hoping to hedge off their risk in stocks they hold.

Goldman Sachs is the prime broker for many hedge funds and investment managers, including my firm, and Goldman Sachs reports long positioning aiming to profit from uptrends in stocks is off the chart.

Once the stock market catches a break and trends up enough, we’ll probably see short covering keep it going for a while.

This doesn’t suggest we buy and hold passively, but it suggests stocks have already declined into downtrends and big institutional money is positioned for further declines, so we have to wonder who is going to keep selling stocks?

Economics 101 is what drives prices, and that’s supply and demand.

There’s been a supply of stock selling that has been dominant over the desire to buy, so prices are in downtrends.

This is when I am looking for the negative sentiment to change.

Last week I shared my observations of fundamentals in Fundamental Valuation: Is the Stock Market Cheap or Expensive? and more granular that some important sectors have reached undervalued status according to CRFA in Are Growth Sectors Technology, Consumer Cyclicals, and Communication Services more Undervalued than Value?.

But the big risk for long-term investors who passively hold stocks, index funds, or mutual funds is I showed in Bear Markets with an Economic Recession Last Longer and are More Severe that if we are in a recession, this bear market will likely eventually get much deeper.

You can probably see why are Shell Capital, we row, not sail, when the wind stops blowing in our preferred direction.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.