More volatility on tap as markets seek meaningful bottom

With signs that the stock sell-off that started earlier this month is far from over, one market watcher urges investors to limit their equity exposure.

Dave Harder, writing for investment research firm Phases and Cycles Inc., argues that technical indicators continue to suggest high risks for investors.

“If the markets were healthy, the selling would have been exhausted on Aug. 5 and markets should be stronger,” he said in a note Friday.

He pointed to last Thursday’s losses — the Dow shed 419 points while the S&P/TSX lost 392 — and noted that market action in the past week was similar to the pattern seen in October and November 2008, when stocks rallied for a while before declining further and settling into a bear market.

“There seem to be few, if any, signs of health or market strength at this time,” Mr. Harder said.

Long-term trend indicators have remained negative for every major global market average, showing that investors are withdrawing funds rather than putting money back into equities, he said.

Meanwhile, long-term oscillators, which offer future projections, suggest most markets are oversold.

“Extreme volatility can occur near these lows. Sometimes the volatile bottoming process can drag on for weeks or even months,” Mr. Harder said.

The long-term oscillator for the TSX is close to fully oversold, he said, and was only lower than this in late 2008.

Noting that markets often have double bottoms that occur about seven weeks apart, Mr. Harder suggested the next low will come about seven weeks after Aug. 8, which would place it in late September.

Advisor sentiment remains surprisingly optimistic he noted, pointing to an Investors Intelligence poll from last week that found 46% of advisors were still bullish and just 24% were bearish.

But based on his reading of the indicators, there could be more volatility before markets hit a meaningful low.

“Those who wish to follow the discipline of the indicators should reduce equity exposure in the next week or so in case there is a more serious decline,” he said.