Time to Buy Stocks?

With stocks in a downdraft and well below recent highs, it’s time to consider the unthinkable question: Is this a good time to add to your stock positions? Let’s look at two pieces of data.

The first is the net flows of mutual funds. Investors have been pulling money out of equity mutual funds for some time, and emerging market equity funds have seen the largest outflows. The funds have seen outflows that rival those of the market lows of 2008. Points of maximum fund outflows can be a good time to invest. At that point, most of the possible panic selling has occurred. The “get me out at any price” selling likely is drawing to a close.

Fund outflows are a contrarian signal for rallies because they show pessimistic investors have already sold, according to Commerzbank AG’s Michael Ganske.

“When things are selling off and investors are very bearish and panicking then it’s clearly a good time to add positions,” Ganske, head of emerging-markets research at Commerzbank in London, said in a phone interview. “There is clearly a compelling argument to reassess exposure in emerging equities as valuations are very, very cheap.”

The strategy of buying emerging-market stocks after weeks when outflows exceeded 1 percent of assets under management produced average gains of 2.2 percent in one month, 8.5 percent in three months and 28 percent in 12 months, according to data compiled by EPFR Global and Bloomberg.

The other reason to consider increasing equity positions is that the stock market indexes are significantly oversold. An investment is oversold when it’s trading below its moving average. Bespoke Investment Group uses the 50-day moving average, while others use a longer period, such as the 200-day moving average. Bespoke says U.S. stocks are oversold by a wide margin:

We certainly don’t have to worry about any sectors being overbought at the moment, however.  As shown in the chart of the S&P 500 as a whole, the index currently sits right at the bottom of the green shading, which is two standard deviations below its 50-day.  Last Monday, the index was four standard deviations below its 50-day, which was something that didn’t even happen at any point during the ’08/’09 financial crisis.

There’s no reason to rush into stocks, despite these data points. They rarely turn on a dime to begin new sustainable rallies after such sharp declines. Also, incompetence by policymakers is what’s moving markets these days. Current economic data indicate the economy is slowing, and it could be slowing rapidly enough to lead to a new recession. It’s too soon to take meaningful new positions in equities.