Stocks are finally oversold for the first time since 2016, but that doesn't mean you should buy the dip just yet, says a Wall Street CIO

• By one measure, the S&P 500 has dropped into oversold territory for the first time in six years.
• But investors should be cautious about viewing current levels as an entry point, according to The Leuthold Group.

This year's relentless sell-off in US equities has finally yanked the market into oversold territory for the first time since 2016, according to The Leuthold Group.

The firm cited its proprietary Very Long Term Momentum algorithm, or VLT. The signal comes with the S&P 500 mired in a bear market — one driven by aggressive Federal Reserve rate hikes intended to fight decades-high inflation.

VLT's oversold reading overall means that a "low-risk buy signal is now mathematically possible," Doug Ramsey, chief investment officer of The Leuthold Group, wrote in a research note published Friday. An oversold reading for VLT is sometimes followed within a month or two by an "excellent" entry point for investors to purchase securities.

But Ramsey stresses that investors should remain cautious, as some previous oversold signals have been followed by continued painful declines.

"VLT became oversold in May 2008, yet the S&P 500 would fall another 51% into its March 2009 low. Not all buy signals from VLT are slam dunks," the five-star fund manager said, adding that the element of time in the market's process of finding a bottom is often overlooked.

The volatile nature of this year's market was on full display this week. The S&P 500 on Thursday, following a hotter-than-expected inflation report, experienced an intraday swing of 5% to finish higher. But investors on Friday hoping to build on that rally were met with a sudden turndown that threatened to erase a bulk of the prior day's gains.

The S&P 500 over the summer underwent a bear-market rally that sharply narrowed its year-to-date loss. But stocks eventually surrendered to further pressure, leading the index back to double-digit percentage declines.

"Patience is advised. We could be writing about the 'impending VLT BUY' signal for many months to come. But this long-term oversold condition should help investors pull the trigger when the time comes," said Ramsey, who noted that Leuthold has followed VLT during its 32 years in the investment business.

Stock drops in late 2018 and in early 2020 — at the onset of the COVID-19 pandemic — prompted the Federal Reserve to pivot from its monetary policy stances. Investors this year have been looking for the Fed to suggest it's ready to pause or fully stop its aggressive rate hikes.

A Fed pivot is "a feat not yet accomplished by this year's much longer-lasting decline. Perhaps that is soon to come," said Ramsey.