The Dow Jones Industrial Average is off almost 8% from its September high: many managers and analysts are now calling the market oversold. But could you be catching a falling knife?

Following a stellar run through the summer, as investors added risk in expectation of a further round of quantitative easing, US equity has fizzled and then fallen. After tracking sideways for a month, the last 30 days have seen a near uninterrupted slide from 13,551 on the Dow on 16 October down to 12,542 on 15 November.

The Dow is now in double death cross territory, deep below both its 50 and 200-day moving averages, the first time this has occurred since May and only the sixth time in the last four years.

Apart from the extended period of weakness that occurred in August 2011, all the other occasions were immediately followed by a sharp bounce, which is what some very authoritative voices – some of which have been near perma-bears in recent years – are now calling.

‘We are now detecting signs that US markets in particular are getting a bit oversold and short-term sentiment measures are dipping into oversold territory,’ said Stewart Richardson of RMG Wealth.

‘The correction over the last few weeks has wiped more than 13% off the Nasdaq index, and we expect the market to stabilise ahead of the 2,440 support area.

‘We therefore adopted a bullish position in the Nasdaq on Friday (16 November) looking for a bounce in the next few weeks.

‘There is clearly upside potential for US equities if Washington moves to a sensible fiscal plan in the days/weeks ahead, and with the next Federal Reserve meeting on 12 December, we believe it makes sense to be thinking more positively on US equity markets in the short term.’

Policy overhang

Others pointed to the policy overhang suppressing risk appetite – in particular the year-end deadline for a US fiscal settlement – as factors which would need to be resolved to catalyse market value.

The last time the Dow stayed below its 50 and 200-day average for a long period was the August 2011 debt ceiling deadlock. With president Obama returned to the White House and the House of Representatives still in opposition hands, many are now expecting a potentially bruising round of brinksmanship.

‘The encouraging noises emanating from Washington make it more likely, although it is still far from certain, that a deal to prevent the fiscal cliff will be reached,’ said Capital Economics market analyst John Higgins.

‘However, the stock market is likely to remain under pressure until a deal is done.’

Institutional investors remain on the fence, with only one in five believing the risks of a bad-tempered round of negotiations are priced into equity, according to a Bank of America Merrill Lynch manager survey.

Similarly, individual investors are feeling as beaten up as they have done for some time. Bullishness fell almost 10% week-on-week in the most recent American Association of Individual Investors survey, to a balance of 48.8% bearish versus 28.8% bullish – the most pessimistic reading since September 2011.

Jeffrey Saut, head of equity at Raymond James and the doyen of US technical analysis, said that despite the unusually oversold market condition, he had not yet identified anything which would resemble an upside confirmation.

Equally, monetary policy provided baseline support.

‘The SPX needs to recapture 1,390 quickly and then sprint above it,’ he said. The S&P 500 currently stands at 1,379. 

‘If not, it probably means we have to go through some kind of bottoming process in the 1,300-1,350 zone. Quite frankly, I don’t see how the S&P 500 can travel much below that given president Obama’s re-election and with that the guarantee of low interest rates for as far as the eye can see.’