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- The stock market is missing one key ingredient to mount a year-end rally, according to Bank of America.
- The bank said that a crescendo of panic selling, or capitulation, is necessary for stocks to bottom in October.
- Favorable fourth-quarter seasonal patterns would support a year-end rally if the capitulation event materializes.
The US stock market is missing one key ingredient for a year-end rally to materialize, according to a recent note from Bank of America.
The bank said that a crescendo of panic selling, or capitulation, by investors in October would set the stock market up well for it to continue rising into the last two months of the year.
"Last week's reversal off Wednesday's spike low on the S&P 500 at 4,238 did not coincide with capitulation on the 3-month VIX relative to the VIX. Given October's reputation for big intra-month drawdowns, we believe that an oversold capitulation event... is more likely in October. This is likely a key ingredient ahead of a year-end rally for the S&P 500," Bank of America technical strategist Stephen Suttmeier said.
Signs of capitulation include the Nasdaq 100 breaking below its support range of 14,500 to 14,700 and the S&P 500 falling below its rising 40-week moving average around 4,230. The Nasdaq 100 currently trades at 14,597 while the S&P 500 is at 4,232.
"A sell-off below the supports for the Nasdaq 100... would also indicate capitulation as investors give up on leadership names. This may be needed for a climactic seasonal low in equities," Suttmeier said.
Other signs of capitulation include 90% down days on the New York Stock Exchange, which occurs when 90% or more of all issues on the Big Board close lower in a given day.
As painful as such a sell-off event would be for investors, it's often necessary to reset market expectations and lay the foundation down for any future upturns.
Such a capitulation event would lead the stock market into a period of favorable year-end seasonal patterns, in which the S&P 500 has jumped 83% of the time and returned 4.3% on average when stocks were up year-to-date through the third quarter, as they were this year. That would put the S&P 500 to 4,500 by the end of the year, which is just 2.3% below its 52-week high of 4,607.
And fourth-quarter gains are even stronger when the stock market is up between 10% and 20% through the third-quarter, as it was this year.
Ultimately, Suttmeier believes the stock market is in a long-term bullish uptrend, and that 2023 will represent a pivotal year for the bull market.
"We think 2023 is like other bullish turns in 2020 (COVID-19), 2019 (China trade war), 2016 (Brexit and Trump elected) and 2012 (Eurozone crisis). Corrections from summer peaks into November 2012, November 2016 and October 2019 tested/undercut the rising 40-week moving average and preceded yearend rallies in those years. The late 2023 setup resembles those from late 2012, late 2016 and late 2019," he said.