Wednesday, November 28, 2018

Bear market or pullback?

In our last post we posed the question, are we entering a bear market?  Our conclusion, this was a correction rather than the beginning of a bear market.  Since then the facts have changed as the market is constantly discounting new information.  Has this altered our outlook?  Lets get to the data and weigh the evidence. 
 
We always like to start from a top down perspective and look at longer term charts first then drill down to shorter term time frames.  Since the 2009 market bottom, the S&P has remained in a healthy uptrend confined by a very clear channel.  The current correction has taken the S&P to the bottom of the channel and a logical spot to find support.  However, the weekly chart shows that we have broken the lower channel support since the 2016 lows.  The daily chart looks the worst as the 50 day moving average is decisively heading lower with a flattening 200 day moving average.  For now, the retest of the October lows has held as the short term trend remains down.

S&P Monthly
S&P Weekly
 S&P Daily


So far from peak to current lows the major indices have corrected between 10-17%

S&P 500          -11.46%
Dow                 -10.50%
Nasdaq             -16.02%
Russell 2000    -16.55%

Yet, if we drill down to sectors it gets much uglier.  Energy, tech, consumer discretionary, industrials, materials, communication services, and financials have all dropped more than the S&P 500.  The two best sectors since the October highs (utilities and staples) are extremely defensive in nature.

Taking it a step further lets look at some of the biggest tech bellwethers and stocks that have driven upside market returns the last handful of years.  These leaders have received a major smack-down from their 52 week highs.

AMZN        -30.73%  
NFLX         -40.93%
FB               -41.98%

GOOGL      -22.39%
AAPL         -27.07%
NVDA        -54.46%

The pundits can argue about what constitutes a bear market.  While the major indices have avoided the bear market threshold so far, we can certainly make a case that a bear resides in specific sectors.  There has been a washout in prior leadership.  What we do know about bear markets is that since 1950, there have been 35 "corrections", where the S&P has fallen at least 10%. Just 10 of these have gone on to become a bear market (defined as a fall of 20%, in red text in the table below; see note at bottom of this post; table from Yardeni, here).
 

A few indicators we watch to look for a potential bottom is sentiment and breadth.  Sentiment remains fearful exhibited by the CNN fear and greed index.  Consensus has turned noticeably bearish in recent weeks as the AAII sentiment survey shows a bearish reading of 47.1% which is the highest reading since February 2016.




Breadth is also creating a positive divergence as the S&P tested the October lows.  We can see the % of stocks trading above their 20 and 50 day moving averages bottomed in October and is now making higher lows.  Couple that with a dry up in new 52 week lows is a positive sign for now.


The old adage is fitting for the current market as bull markets take the stairs up and the elevator down.  This market correction feels worse in real time but in reality this is normal in an ongoing secular bull market.  On average, the market falls 14% intra-year from peak to trough.  This is the second drop of greater than 10% for the indices this year, making diagnosing 2018 so difficult.  However, if the October lows hold, the foundation is set for a potential bottom in place and a rally to resume.  Seasonality, breadth, and sentiment favors the bulls but price action remains on shaky ground.  As we enter the final month of a very volatile year there isn't a shortage of themes and landmines.  Will the January effect hold, another Fed meeting, trade talks, debt ceiling, etc.  We tend to lean towards the bullish thesis, yet, managing risk is our number one priority and if the market breaks down through the current lows we expect a larger drop which could be the makings of a bear market, at which point we'll reassess the facts.