The early summer weeks of
June have not been kind to the US
stock markets. Across
June’s initial 8 trading days, the flagship S&P 500 stock index
lost 4.6% of its value. This is
not a trivial move for America’s
biggest and best elite companies, so stock traders are starting to sweat a
bit.
As usual, Wall Street is
generally pretty bullish despite the recent selling. It is largely perceived as a minor
pullback within a big new bull upleg, a stellar
buy-the-dips opportunity. But what
if this is not the case? An
alternative, and far-more ominous, interpretation of this past month’s
weakness suggests we could really be witnessing an awakening bear.
If you aren’t a
contrarian or haven’t studied financial-market history, the notion of a
new bear probably seems preposterous.
I am not happy with this thesis either, as bear markets are much more
challenging to thrive in than bull markets. Nevertheless, the case for a new bear
is getting pretty compelling. And
if a bear is indeed stirring, it is far more prudent to prepare for it
instead of burying our heads in the sand.
The case for this new bear
begins with stock-market technicals. The average price action in the 500
individual stocks comprising the S&P 500 (SPX) has been growing
increasingly negative. With this
index trending lower, the supplies of component shares offered by sellers are
generally exceeding buy-side demand.
Sellers outnumbering and overpowering buyers is one of the core
bear-market attributes.
A
year ago, the SPX technicals still looked
bullish. In July it hit a new
all-time high of 1553 within weeks of finally surpassing its old high-water
mark of 1527 from way back in March 2000. There was a sharp selloff
soon after this top as the initial subprime scare
hit, but the SPX soon recovered. By
early October it again hit fresh all-time highs near 1565. Together this pair of highs now looks
like a secular double top.
At its apex early last
autumn, the SPX was up an awesome 95.5% in a mighty bull run that started way
back in March 2003. Over this
entire 4.5-year span, the general US
stock markets as represented by the SPX never experienced a single major
correction. Such a long span of
time with a unidirectional prevailing trend is rare, as stock-market action
is usually fairly cyclical. Corrections
follow uplegs and bears follow bulls.
While the SPX bull was
certainly quite long in the tooth by its October high, technically there was
no real evidence of bear-market action until late November. That is when the SPX finally broke
materially under its key 200-day moving average. 200dmas generally provide strong
support in ongoing bull markets.
Any pullbacks or corrections usually bounce at or slightly below the
200dma if the bull uptrend remains intact.
But in late November, the
SPX briefly fell under 0.95x its 200dma.
Such levels had not been witnessed since early 2003, the last time the
SPX was in primary bear mode. Its
200dma was failing as support, a key sign of an aging bull starting to give
up its ghost. If you are a Zeal
subscriber, you can see this for yourself on our long-term Relative SPX chart
located in our private charts section under General Stock Markets.
In early December the SPX
surged above its 200dma once again, but this recovery attempt was
half-hearted. The selling soon
overwhelmed buying again and the index headed south. By early January the SPX had broken
decisively below its 200dma and the 200dma itself
was rolling over. Since a 200dma
usually runs parallel with a price’s primary trend, this was another
clue that the long bull since 2003 was in serious trouble.
By mid-January the SPX was
freefalling along with stock markets across the globe. I explained the factors driving this
wickedly-steep mini-panic in depth in the February issue of our Zeal
Intelligence newsletter, which is now in our web archives for
subscribers. Technically this
particular selloff defined the downtrend labeled “bear downleg”
in the chart above. The
SPX’s 200dma had totally failed, something
that does not happen within ongoing bull markets. Traveling
for long under a 200dma is bear-market behavior.
From its early October high
to its latest mid-March low, the SPX lost 18.6% of its value. This is such a big and fast decline
that it looks vastly more bear-downleg-like than
bull-correction-like. For
instance in one of the SPX’s biggest selloffs
within its March-2003-to-October-2007 bull, the SPX fell 7.7% in
mid-2006. Another big one in 2004
fell 8.2%. Mid-bull pullbacks in
the SPX are usually less than 10%, minor.
Within bears though,
individual downlegs can easily push 20%+. In early 2001 during its last bear
market, the SPX fell 19.7% in a single quick (just over 2 months) downleg. The
far-more-brutal downleg ending in July 2002
witnessed a 31.8% SPX decline in just 4 months! So SPX declines approaching 20% like
our recent one did are something seen in
primary bears, not primary bulls which usually only see sub-10% pullbacks.
By mid-March, fear was so extreme as measured by technicals
and key fear gauges like the implied-volatility indexes that a major rally
looked imminent. In the March
11th Zeal Speculator regarding the
SPX I wrote, “Even if we are in a new bear, we need to see fear abate
periodically to rebalance sentiment.
New downlegs launch out of greed, not
fear. Only a strong rally will
dissipate all of the excessive fear today and bring back greed. Thus I still think we have a good
chance of seeing the SPX rally up to its 200dma.”
And the SPX did indeed
rally sharply off its V-bounce in March.
Declines of many months suddenly steepening
into a plunge, carving a V-shape, and then soaring are classical and common
bear-market stuff. Such V-bounces
are seen at the end of nearly every downleg in
bears but only rarely in bulls after a huge exogenous shock like the
Long-Term Capital Management hedge-fund implosion of 1998.
After this V-bounce, the
SPX climbed fairly aggressively until mid-May. Its 12.0% bear rally was certainly
weak by bear-market standards, but it still looked like a bear-market rally
technically. In the four major
bear rallies the SPX saw back in its 2001-to-2002 bear days, this index rose an average of 20.5%. But back then the stock markets
weren’t facing today’s tremendous headwinds driven by a credit
crunch coupled with an energy crisis.
And when this rally topped
in mid-May, the specific technical level the SPX reached is very
telling. It was repelled right at its 200dma. Just as 200dmas are major support in
bull markets, they are major resistance in bear markets. Any student of market history will
quickly learn that the highest-probability stopping point for any bear-market
rally to run out of steam is near its 200dma. The bearish technical signs keep
adding up.
After failing at the
SPX’s 200dma, the index started selling off again. It reached its 50dma by late May, an
important level of support if this was bull-market action. While it bounced off its 50dma
initially, this was an anemic bounce. If we were merely witnessing a
pullback within a bull-market upleg, the 50dma
would usually hold.
But in early June, actually
last Friday during that giant $10 oil spike, the SPX broke decisively under
its 50dma in a big 3.1% down day.
Not only is a failing 50dma a telltale bear-market sign, but so are
big down days. The great majority
of the SPX’s biggest daily swings of the last
decade happened during its bear years.
Bears see more extreme days than bulls in both directions, down and up.
So as you can see, all
kinds of SPX technicals are now doing things that
are usually only seen during primary bear markets. The price behavior
we’ve seen since early October has been very bearish. While such action certainly
doesn’t prove we are in a new bear, it sure radically increases the
odds that we are. When price
action looks like a bear, feels like a bear, and acts like a bear, it just
might be the real deal. If the
SPX decisively breaks its critical support at its March lows in the coming
months, a bear is upon us.
But until that happens, technicals alone are not enough to call an early-stage
bear. Bears just don’t
erupt randomly, very specific conditions entice them
out of hibernation. When stocks
rise for too long without any material correction, and greed waxes extreme,
bears emerge to rebalance sentiment.
And per the sentiment gauges like the implied-volatility indexes and
the put/call ratio, greed did indeed reign back in early October when the SPX
peaked.
But there are also longer
stock-market cycles that define bears.
I call these Long Valuation Waves, or LVWs. Throughout stock-market history, great
cycles exist covering a third of a century each. Great 17-year secular bulls are
followed by 17-year secular bears, together making one LVW. Today we are in the secular-bear stage
of our current LVW. If this is
new or unclear to you, please read my latest LVW essay to get up to
speed.
Within the second half of LVWs, their bear stage, stock markets generally grind
sideways. This gives underlying
stock earnings time to catch up with inflated stock prices from the top of
the preceding bull stage (ending March 2000). Gradually this process reduces stock
valuations (where stock prices are trading relative to their profits) to
first normal and then ultimately undervalued levels by the end of the bear.
Since early 2000, the SPX
action has been just as expected within such an
overarching 17-year bear. Sure,
stocks had a mighty run from early 2003 to late 2007, nearly doubling. But big cyclical bulls are common within great bears,
they keep stock traders from getting scared out too early in the secular
bear. Despite all the sound and
fury of this massive SPX run though, by October 2007 the SPX was still only
2.5% above its March 2000 levels!
Thus the SPX was
essentially dead flat over nearly 8 years, it just traded sideways! Investors who bought stocks in late
1999 or early 2000 along with the popular mania had just started breaking even
again by late 2007. General
stocks were terrible investments over this span. Overlaying this 2000s sideways action
on top of the last great-bear grind from the 1970s is very revealing. The white and yellow numbers are SPX
P/E ratios for their respective eras.
The blue line showing our
current SPX looks quite similar to this same stage in the last LVW. If this chart interests you, I
explained it in much more depth in an essay back in January when the
SPX started to look bearish to me.
But for today’s purposes, just note that the SPX has traded
sideways at best since early 2000 and that strong cyclical bulls and bears
alike are common within these
17-year great-bear grinds.
The fact that the SPX just
hit its secular resistance in late October radically increases the odds that
we are in a new bear market. If
the very same bearish technicals we have witnessed
since October happened low in this trading range, like down under 1000 on the
SPX, I wouldn’t worry about them.
But seeing so many bear-market signs emerge off the very top of a
nearly-decade-long trading range demands we take them very seriously.
Even more provocative are
the comparisons between today’s LVW progress and this same stage in the
last LVW in the mid-1970s. Near
its recent peak, the SPX was only trading around 21x earnings. Many Wall Street analysts, and rightly
so, said such valuations were nowhere near the 44x peak bubble extremes in
2000. To them, such relatively
low valuations suggest this bull has plenty of room to run higher yet.
But back at this stage in
the 1970s LVW, valuations had moderated too. The SPX was trading near 19x earnings
as 1973 dawned, a better value than the 21x of October 2007. Yet despite this, the index still got
sucked down in one of the most brutal bears of the modern era in 1973 and
1974. As this next chart which
zooms in on the cross-LVW comparison around this time shows, the SPX still
lost nearly half its value!
From early 1973 to late
1974, less than 2 years, the mighty flagship SPX full of elite American
companies fell by a devastating 48.2%!
It was horrifying. Much
like last autumn, the stock markets simply started selling off after a strong
multi-year bull. In the
early-1970s equivalent to our recent 2003-to-2007 bull, the SPX gained an
outstanding 73.5%. The myriad
parallels between then and now are ominous.
We are at the same stage in
our current LVW now as we were early in the 1973-to-1974 bear in the last
LVW. That bear started at 19x
earnings while our latest SPX top was at 21x earnings. That bear started just above the top
of the SPX’s secular trading range, just like our current technical
weakness. And back then, just
like now, spiraling oil prices and inflationary
expectations were really weighing on Americans and hence the US economy
and stock markets.
So the bearish SPX technicals we’ve seen since early October should be
placed within the strategic context of our current position within our Long
Valuation Wave. They are not happening
in a vacuum where we can blissfully ignore them. Similar conditions in the last LVW, at
this very time within it, sparked a terrible bear that cut the SPX in half in
less than 2 years. These are dire
tidings indeed, no fun at all.
Obviously I don’t
know for sure if we are indeed in a young bear, but the more SPX action I see
since October 2007 the more bearish things look. In light of all this, which I have
barely brushed upon in this essay, it would not surprise me one bit to see
the SPX down near 800 by autumn 2009!
It sounds crazy, but this is what historical precedent suggests is not
only possible but probable. Investors
should really be cautious here.
And one of the worst things
about all this is bear markets are so darned devious. A bear wants to maul as many investors
as possible, so it has to obscure its existence as long as possible. Thus any steep declines like
we’ve seen recently are soon followed by sharp rallies. The
biggest stock-market up days ever witnessed in history happen during bear-market rallies. These fast bear-market rallies quickly
calm fears and convince investors that “this couldn’t possibly be
a bear”.
So even if the SPX is
whittled down to half its October 2007 peak, near 800, for most of the
journey down Wall Street will insist everything is fine and a major bull is
just beginning. It always works
this way. General psychology
doesn’t actually get bearish until the terminal stages of bears when
investors realize they’ve been played for fools. So recognize that sentiment and
feelings don’t betray a bear until far too late.
On an averages basis, bears
are boring too. The average daily decline in the
wicked 1973-to-1974 bear, still remembered as one of the worst, was merely
0.1% per day. This is
nothing! Like the proverbial
turning up the heat to boil a frog slowly, bears gradually boil investors
before they realize it. Most of
the time bears just barely grind lower.
Big down days are rare, usually only seen late in downlegs. And big up days out of those lows are
common. Bear markets are so Machiavellian in the way they
subtly unfold.
Investors looking for a
bear in day-to-day action or short-term charts won’t find one. Even on charts running a month or two
back, most of the time in a major bear that particular slice of time
won’t look too bearish in isolation. Only traders who can keep the
long-term strategic picture in clear focus can hope to identify a bear early
enough to avoid the worst of its ravages.
At Zeal, we actively traded
the last major SPX bear, which was primarily in 2001 and 2002, to outstanding
success. In 2001, the SPX fell
13.0%. That year all our realized
stock trades recommended in our monthly newsletter gained an average of 10.1%
absolute, or 29.3% annualized since our trades virtually always run less than
a year. In 2002, the SPX fell 23.4%. That year our stock trades gained
40.5% absolute or 129.1% annualized!
Bear markets can indeed be traded successfully by battle-hardened
traders.
So if you want to make this
next probable bear-market journey with traders who have thrived in just such
a hostile environment in the past, join us. We publish an acclaimed monthly newsletter analyzing the
markets and launching real-world trades based on our research. And we publish a separate weekly newsletter doing the same
for more-active speculators. We
will continue to actively trade, and hunt for profits, even in a bear. Subscribe today!
The bottom line is recent
technical action in the US
stock markets is looking increasingly like we are already in a new cyclical bear. Sellers are overpowering buyers with
increasing ease and stock prices are falling on balance. If such a bear follows historical
precedent, it is not unreasonable at all to expect the major US stock
indexes to fall to half the levels
of their early-October highs before this bear fully runs its course!
Merely knowing that we may
be in a new bear will give you a huge psychological edge over the majority of
investors who will remain clueless until near the very end. While bears are much tougher trading environments
than bulls, they can still be traded profitably by the prudent. Remain wary and keep the big picture
in focus, refusing to be seduced into unbelief by the big up days so common
in bears.
Adam
Hamilton, CPA
Zealllc.com
June
13, 2008
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information.
Thoughts, comments, or
flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually
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messages though and really appreciate your feedback!
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Research (www.ZealLLC.com)
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