Even though the Federal Reserve and Janet Yellen couldn’t ignite a further rally on Wednesday, through a multiweek/multimonth lens, the broader U.S. stock market remains heavily oversold.
One way to play a much-needed oversold bounce is by looking to the most oversold part of the market — and right now, I think the opportunity is transportation stocks, as represented by the iShares Dow Jones Transport. Avg. (ETF) (NYSEARCA:IYT), which includes stocks like FedEx Corporation (NYSE:FDX), United Parcel Service, Inc. (NYSE:UPS) and Union Pacific Corporation (NYSE:UNP).
Structurally many stocks already find themselves in a bear market, which is to say that any oversold bounce that I am expecting from last week’s wash-out lows will likely only lead to lower highs and thus ultimately see lower lows still before this bear market has run its course.
A key characteristic of bear markets is the tendency for sharp oversold rallies that catch greedy bears by surprise. This then leads to short covering activity, whereby short sellers have to buy back stock to stop out their short positions, which feeds on itself and adds further fuel to the rally. Just when the greediest of bears and weakest short sellers are all stopped out is typically when the selling resumes.
This is a crucial dynamic to be aware of as we traverse the first cyclical bear market in stocks since the 2009 financial crisis lows.
IYT ETF Charts
Nonetheless, last week the IYT ETF reached oversold readings as measured by the MACD last seen at the 2009 capitulation selling lows. From a price action perspective, the IYT also left behind on its weekly chart a strong bullish reversal, which occurred right at the bottom of the range as marked by the two black parallels.
Over on the daily chart, we see an equally dramatic oversold reading in the MACD and just about any other momentum oscillator. Simply put, the IYT ETF has gotten too far removed from its medium-term moving averages to stand any reasonable chance of continuing to drop at this rate.
The bullish reversal on the daily chart last week was completed last Friday with an up-gap and rally day.
Active investors and traders could use the IYT ETF to play a potentially sharp broader market oversold bounce, using last week’s lows near $115 as a stop of last resort.
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