The bear market that began in late December is following the script of previous bear markets pretty closely including a very predictable short term low that developed late last week. If things play out as they have in the past in terms of investor behavior, price patterns and timing, then we should still be looking out several months from now for our first opportunity to add back some market exposure. Should you buy now? Not Yet.
Regular readers might have caught the label. Yes this is a bear market and not a correction. The process of this market top began in July of 2014 (not 2015), and completed the topping process in December of 2015 after a long, painful, “flat” 12 months of churn. Price patterns, loss of leadership, average declines across a majority of stocks, sentiment, breadth and volume all confirm what we would describe as bear market conditions. The financial media is still waiting for the S&P 500 or the Dow to cross below the -20% level before giving it the title but those are really just silly benchmarks. If history repeats, these are always the last indices to fall into bear market loss territory. The average stock in the NYSE and the NASDAQ are already down well over 20% from the highs, while the average small cap stock is down 30% or more. Global stock indices are down 15-17% from the highs with several less developed countries down in the 20’s and 30’s in percentage terms. I’m being non-specific about numbers on purpose. These are bear market conditions with bear market losses everywhere so waiting for one index or another to ring the bell in order to give the whole environment a title is somewhere between denial and not paying attention. Let’s accept it and move on.
Short Term Low in Place
Starting on January 15th, extremes began to show up for those of us watching technical indicators like sentiment, breadth, overbought/ oversold, price support and volume. We spoke specifically about a target of 1850 on the S&P 500 as a likely short term stop and indeed the S&P 500 hit that mark almost exactly at the lows, closing at 1859. The doomsdayers hit the media over the Martin Luther King weekend, calling for a crash and the end of modern day capitalism as we know it. By the end of the next short market week, stocks finished up 1.4% on average breaking the panic and fear in the system. So where are we now? How does the pattern play out from here? Well the short term bear market bounce should continue into early February or so pushing prices up to 1950 - 1972 on the S&P 500 before sellers take control again. The average bear market rebound is between +6.5% and +8%, which would almost erase the YTD losses. We’re not expecting that much of a bounce but those are the stats. This week, our fearful Federal Reserve will once again bend to the will of foreign central banks and talk down their conviction to raise interest rates in 2016. I will be very surprised at this point to see a rate hike until June. Q4 earnings hit the market in February and March and given the challenging year over year comps (Q4/2015 vs. Q4/2014), I’m going to say the market will be volatile. This morning, Lowry’s Research made a very bold statement saying the conditions for a sustainable low in stocks are not present, not really even close. They pointed to two dominant variables that suggest the markets are still in a very high risk place. The first is the state of the their proprietary Buying and Selling pressure indices (sell below). Notice how the Buying Pressure made a new low last week while Selling Pressure made a new high. At sustainable market lows, these trends are reversed even as prices continue to fall marginally or carve out a multi month bottom. Also notice how the two indicators did not definitively separate until December of 2015, as the NYSE was still trading marginally above the 200 day moving average. These are the twilight zones of a top and one of the reasons we have been reluctant to say we were in a bear market – until now.
The other condition presented by Lowry’s was the state of something called the Operating Companies Only (OCO) Advanced Decline line which broke below the August, 2015 and October 2014 lows last week. This indicator has unfortunately been pretty good at forecasting the future of the markets not in timing but in magnitude. In other words, following this lead we should not expect the August lows to hold before we see the development of a sustainable bottom. High yield corporate bonds and small caps are also telling of the same outcome. Technicians will describe the current short term level as an “internal” low or a momentum low, but not the final “external” low.
Investor Options in the Weeks Ahead
There are several options now available to all investors depending on your views and expectations. They are as follows:
- 1.Do nothing
This is the option for the folks who are passive investors, who stay the course no matter what. They believe generally that markets always go up and that any effort to manage risk is futile. Adjusting exposure is not part of this investor’s process beyond timely rebalances. Those rebalancing windows should happen at market extremes when bonds are high and stocks are low (by selling bond positions and buying more stock). As mentioned above, we don’t believe we’ve seen those price extremes yet in either asset class.
- 2.Prepare to cut exposure on a rebound
Investors, who are still feeling overexposed to equities and have a clear process in place for risk management, could use any rebound as an opportunity to reduce exposure. You will need to sell into strength, which is difficult for most as we feel that tomorrow’s gain could be even better than today’s gain right? Determine now how much net exposure you want to the financial markets and plan to be at that level as (if) stocks rebound from here. In our all equity models, we are sitting on 40-45% cash. Remember, in a bear market, selection matters much less than exposure, as all ships tend to move up and down together in a highly correlated dance. In fact all global stock markets are now moving very much in sync in both timing and magnitude so there isn’t much use in shifting your money across oceans either. I took a snapshot of the end of day move from a basic Fidelity app on Friday as the picture was worth a thousand words. All up, all by the same amount, across the globe. These blue circles are periodically different colors and sizes based on the various price action in different parts of the world but more and more often, they all look the same. It is truly a global stock market these days and frankly has been for the last several years. As a side note, this is one of the primary reasons we changed our equity benchmark to the Dow Jones World Stock Index (50% US/ 50% the rest of the world)
This is also an option on any rebound but generally not one I would recommend unless you know what you’re doing. This involves buying a short market position against your own internal “long” positions in order to hedge out the systematic risk in your portfolio without necessarily selling positions and potentially generating tax liability. We have the capacity, the will and the experience to this in our Tactical Equity and Blended Asset models.
We’ll Let You Know
As always, we try to be good about telling our clients when to add new money to your investment portfolios via our “Calling All Cars” message. Last August, before we had enough evidence to support the current bear market thesis, we saw a clear opportunity to recommend adding new money to investment accounts and we did so. At present the market is still trading slightly above those levels. That recommendation may or may not prove to be a good one considering our expectation of lower lows. But conditions were discounted then and conditions are discounted now. In the current environment, we think there will be better discounts available in the 2nd quarter or even the 2nd half of the year. So for now, we’re not recommending adding new money to investment accounts. We’ll let you know.
That’s it for now, stay tuned