Conditions are falling into place for a seasonal Q4 rally, says Ari Wald, Technical Analyst at Oppenheimer.
Wald points out that sentiment survey data are at multi-year pessimistic extremes and mean reversion is typical in October. In fact, he shows that Octobers which start in a downtrend have been followed by the best performance of any month, whether in an uptrend or downtrend, since 1950 (see Chart 1).
Before this happens, however, Wald thinks a test of the August low remains a reasonable expectation as part of a basing attempt; a three-stage bottoming process that ends with a “less-intense” test and potential undercut of the 1867 support (see Chart 2). Following that, Wald expects a Q4 rally to take the S&P to the underside of its 200-day moving average, currently at 2065.
Wald recommends buying selectively for the Q4 rally, choosing stocks that have behaved well through the volatility. He expects the strong stocks to get stronger out of the correction because they are faced with less resistance. Conversely, he thinks that stocks that have broken trend should be sold on strength.