3 Commandments For Investing In A Shaky Stock Market

After a higher opening, the SPDR S&P 500 ETF Trust SPY is trading flat on Tuesday and could be on track for its fifth consecutive down day.

In volatile and unpredictable markets, DataTrek Research co-founder Nicholas Colas says it’s important for investors to remember three commandments of investing.

First, Colas said investors shouldn’t make things harder than they have to be. He said investors should keep September’s bearish trading action in perspective. The 8.4% September sell-off is the third pullback of the large market recovery since the March lows. In each instance, the same dynamics have been in play -- investors banking on expectations for a large earnings recovery at some point, but being uncertain about the timing of that recovery.

Second, Colas said stock market trading action is a leading indicator of fiscal fundamentals. He said a general rule of thumb that has worked well is the “5% rule,” which suggests Congress is unlikely to take action with stimulus legislation unless the S&P 500 has at least one 5% single-day drop.

Throughout 2020, DataTrek has been recommending investors buy stocks at the close of every 5% down day, a strategy that has historically generated tremendous six- to 12-month returns for investors.

Finally, Colas said investors should have a clear understanding of upcoming market catalysts and what the market price action surrounding those catalysts means. For example, Colas said history suggests third-quarter earnings season will likely be a bullish catalyst for the stock market, but investors should be on the lookout for a 5% down day.

“This would signal that markets have shifted from the earnings leverage story, typically a very powerful one early in a cycle, to worrying about a 2008 replay of a crisis where DC is AWOL,” Colas said.

Benzinga’s Take: Expectations could not have been lower entering the second-quarter earnings season, so it’s not surprising most reports exceeded those expectations and the stock market responded positively. Expectations are still pretty low for the third quarter as well, with analysts anticipating S&P 500 EPS will be down 21.8% from a year ago.

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