Two days ago, the S&P 500 did something it hasn’t done in 6 months: it fell below its 50-day moving average (MA).
Another thing the S&P 500 hasn’t done in 6 months is sell-off by more than 2%.
But as I write, the S&P 500 is 4.4% below its record high from March 28.
The rout for stocks is on.
There is fear in the air for investors that thought AI was a one-way ticket higher for stocks like Nvidia and AMD. It is time to follow Warren Buffett’s timeless advice to be greedy when others are fearful. It is time to look for bargain priced stocks that aren’t dependent on wide-eyed speculation for their prices to move higher.
I’ve got a couple ideas for you, which I’ll get to in just a minute.
But first I’d like to put this sell-off in perspective.
Man Vs. The Machines
It’s well-documented that 70% of New York Stock Exchange trading on any given day is executed by algorithm trading machines. This may seem unfair – how can any individual investor compete against an algorithm that can execute trades in the blink of an eye?
Well, you can’t. And you shouldn’t even want to, unless your plan is to scalp pennies off of stocks as they move by executing dozens of lightning-fast trades. No, leave that for the trading machines.
The fact is individual investors can give themselves an edge by simply understanding how these trading algorithms work. The best analogy for these algorithms is a light switch. When the switch flips to buy, they buy and the market chugs relentlessly higher…
And when the switch flips to sell, it’s the same thing in reverse – stock prices chug relentlessly lower.
It’s pretty easy to recognize when it happens – just look at a chart for the S&P 500 from November to March
The key to understanding the trading machines is the algorithms that flip the switches from “buy” to “sell.” These algorithms scrape headlines, like whatever the Fed is saying about interest rates and inflation. And they react to technical signals, like the 50-day moving average (the gold line on the chart above).
Last November, both came into play. The Fed said it would cut rates. And then look what happened when the S&P 500 broke over that gold line.
All the machines started marching stocks relentlessly higher. And the machines always march together because at the end of the day, they’re all programmed the same way, with the same signals.
Lately, the switches started flipping to “sell” when inflation data put the lie to the Fed’s promise. The S&P 500 dived below the 50-day moving average on Monday. And yesterday the algos got the full confirmation: Fed Chair Powell himself said rates probably won’t get cut this year.
How to Know When the Coast is Clear
Now that a sell-off has really begun, it’s time to zero in on some stocks to buy. I wrote up Caesar’s Entertainment (NYSE: CZR) for you a couple weeks ago (you can read The Case for Caesar’s HERE). There’s a lot of upside for Caesar’s.
Vegas is booming. Caesar’s earnings will grow from $1.18 a share this year to $2.40 next year. You just don’t find that many companies that are about to double their earnings. Especially not ones that trade with a forward price-to-earnings ratio of 15.
Researching Caesar’s, I dug into DraftKings (NASDAQ: DKNG) and liked what I saw. The company is turning to profitability right now. Next fiscal year revenue should grow nearly 20% and its first full year of profits will amount to $0.78 a share. And analysts have raised their estimates twice in the last 30 days which is a very good sign that for DraftKings, business is booming.
As for when to buy, rallies tend to give back around a third of the advance when they pullback. So this sell-off might take the S&P 500 down to 4,900. Or you could just average into these stocks.
Briton Ryle
Chief Investment Strategist
Outsider Club
X/Twitter: https://twitter.com/BritonRyle
Check out these recent Outsider Club articles:
The Case For Caesar’s (NYSE: CZR)
