Study: the stock market's short term downside will be limited


Over the past 2 weeks I said that the stock market would face some short term downside (i.e. would swing sideways or fall a little). So far I’ve been right. The stock market has gone down a little bit (see S&P 500).

The Dow has gone down 5 days in a row. What’s particularly interesting is the fact that the Dow has fallen less than -0.5% during each of these down days.
In other words, the Dow is grinding downwards.
This is unusual because the stock market usually takes the staircase up and the elevator down.

Here are the historical cases in which the Dow fell 5 days in a row, while falling less than -0.5% each day.
Here’s what happened next to the Dow.


Notice how bullish the Dow’s forward returns are on a 2 week forward basis. Positive 84% of the time. This means that even if the stock market does fall a little more in the short term, the downside will be limited.

Here are the historical cases in which the Dow fell 5 days in a row, while falling less than -0.5% each day.
Here’s what happened next to the S&P 500.


Notice how the S&P 500’s forward returns are extremely bullish on a 3 week forward basis. Positive 95% of the time. This means that even if the stock market does fall a little more in the short term, the downside will be limited.
Click here to download the data in Excel.

Conclusion

This study suggests that the stock market could fall more in the short term, but this downside will be limited.
The S&P was positive in 18 out of 19 cases 3 weeks later. The only loss was very small: -0.5%
The logic behind this is simple. When the stock market is crashing, it doesn’t “grind downwards”. It’s supposed to crash. A “grind downwards” pattern isn’t bearish.
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