Why the stock market sold off Tuesday and how investors can decide when to buy

Published Wed, Apr 3 20246:00 AM EDTUpdated Wed, Apr 3 20244:24 PM EDT

We knew Tuesday's selloff was coming. Not because we're fortune tellers but because that's what always happens after a period of strength. We didn't know exactly when it would happen. Nobody ever does. But we knew that as the strength continued to build in the market, we had to be ready. For some, that means playing options or shorting overheated stocks to hedge the downside. For the Club, however, it meant ensuring that we were raising cash into the strength and building up a sizeable cash position so that we were in a position to take advantage of the action we are now seeing. Here is what's going on. Earnings season is a little over a week away so it could be that folks are gearing up and raising cash to take advantage of the dislocations that often occur as results get reported. That could be some of it. But more likely the culprit is interest rates. According to the CME Fed Watch Tool, the odds of a June rate cut by the Federal Reserve have slowly diminished over the past month. One month ago, the market attributed a 26% likelihood that the Fed would hold rates steady in June. The odds of that ticked up to about 30% a week ago. However, as of Monday, the first trading day following the release of February's in-line personal consumption expenditures (PCE) core price index (when the market was closed for Good Friday), the odds of a Fed hold in June jumped to just over 40%. When rates are expected to remain higher for longer, equity prices need to adjust — be it via an increased discount rate in discounted cash flow models, or multiple contraction. The higher-for-longer risk has also boosted bond yields over the past couple of days, which also puts near-term pressure on stocks. And, it didn't take much, with the S & P 500 up over 27% since late October 2023, before this latest bout of selling started. That's about six months. We would be crazy to think annualized returns of over 50% are sustainable. Some giveback after a run like that is not only to be expected but should be desired by long-term investors because it ensures a healthy market and provides an opportunity to get more cash to work. Jim Cramer said Tuesday in a special video Homestretch that the Club is "watching and waiting." He mentioned a handful of stocks that are nearing buy levels but bigger declines would need to bigger. Best Buy , which we added to the portfolio last week, and Abbott Laboratories fell into that category. Jim also said Palo Alto Networks is at a level that "I'm very interested in." So, with stocks selling off and cash at the ready, the question is, when do we step in? For starters, we can take some solace in the fact that this is largely a rate expectations-based selloff, and not the result of some key economic reading that has us thinking the Fed messed up and we're now on the hard landing path. For the most part, things haven't changed too much from what we've heard from company management teams over the past few months, either on earnings calls or during industry conferences. That tells us that we can lean on our earnings scorecard's Great or Good sections to help us choose which names to target first. Investment opportunities result from a dislocation between the stock price and the fair value of the business. That happens when the stock of a fundamentally strong company, is in decline. The fourth quarter was a pretty great one for Club stocks. Once targets have been identified, the question is, when to pull the trigger? That's not so easy to determine in a market-wide selloff. So, don't make statement buys and use up all your cash too quickly. You still want dry powder when earnings season starts. Instead, let the stocks come to you. Don't feel you must jump in here and now, on what could well be the beginning of a multiday slide. Start thinking about the levels you want to buy at. Determine them now so that if/when they hit, you can take advantage of the moves, and take comfort in knowing that you decided to buy at a far less emotional moment in time. The first thing to consider is valuation . Watch earnings estimates and look to buy at valuations that are in line with or below what we've seen in the recent past. The five-year average on forward price-to-earnings ratios is a good benchmark. But it would also be a good idea to consider the valuations since late 2021, right before the Fed started hiking rates. Rates may be higher for longer — but if the next move is indeed a cut, then it means there should be a good margin of safety if you can pick up shares at valuations at or below what investors were willing to pay into a rate hiking cycle or while rates remain at these elevated levels. Technical stock analysis can also be a helpful tool , especially when the selling becomes indiscriminate, as is often the case in a market-wide pullback or a full-blown correction. A correction is defined as a decline of 10% or more from recent highs. We're nowhere near that yet. We've provided some examples and lessons on technical analysis in past commentaries: here , here , here . Given these articles are dated, focus more on the metrics and signals we address, rather than the specific entry points. Some may still be relevant, but it's important to remember that charts are constantly changing so things like the moving averages we called out then won't be at the same as current levels. The two big levels that technical analysts watch are the 50-day and 200-day moving averages. When a stock is trading above these levels, then investors will look to these levels as support (meaning levels that might serve as a near-term floor). When stocks are selling off, you want to be mindful of the volume trend. Don't go rushing into with a large buy when the selloff is happening on high volume, which could indicate large positions being unwound, something that could take several days. Instead, look for the selling pressure to alleviate – look for the stock to start trading sideways and/or for volumes to decline over time as the selling pressure eases. The relative strength indicator can also be useful. An RSI move below 30 indicates oversold conditions. Importantly though, never forget that oversold does not equate to undervalued . Those are some items to watch at the stock-specific level. However, we also monitor market-level technicals . The two big metrics we like to watch are the S & P 500 Short Range Oscillator and the ratio of down volume to up volume on the NYSE. Regarding the Oscillator, a level below minus 4% indicates oversold conditions in the S & P 500 and over positive 4% indicates overbought conditions. After the sessions on Thursday and Monday, the market was flashing overbought conditions. That's one of the reasons trimmed Disney and Alphabet , which had been on recent runs higher. Our Club discipline states we must consider some selling when the market is overbought. The Oscillator after Tuesday's close moved more toward neutral. The down/up volume ratio also helps us determine when a selloff is starting to get long in the tooth. Here, we want to see a ratio of about 10:1 down to up volume. During Tuesday afternoon's trading, we saw a 7:3 ratio, meaning that 70% of the NYSE volume was to the downside and 30% was to the upside. We'll need an even greater flush out to hit that 10:1 level. You don't always get it but when you do, you have to hold your nose and do some buying. All of these tools don't always line up but knowing what you are looking for and combining these indicators with your fundamental stock views as well as the economy overall will help better determine solid entry points. They will also help ensure each buy counts. (See here for a full list of the stocks in Jim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. 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A trader works on the floor of the New York Stock Exchange during the opening bell on April 2, 2024.

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