Editors Choice

Tuesday, 23 October 2018
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Bear Market Or Not

It is different walking into the office. As it was in February. “How many points was Wall Street down” says a colleague as he walks in this week. That morning the Dow Jones was down 127. The assumption that markets will fall instead of rise is a rare state of mind in the broking world, it only happens in a bear market. Of course, nobody knows if a bear market has started, but the mere fact that we are discussing it is in itself a sign. The 7.8% fall in the market is another.

Those that do declare a bear market are reckless to do so,  their hollow predictions no matter how confident and no matter how eloquently expressed, are little more than attention-grabbing guesswork, and somewhat irresponsible. But financial market commentators/brokers/media know that "calling the crash", no matter how unfounded, attracts attention. It gets hits to run against the herd and invoke fear, it gets hits to suggest everything is going to hell in a basket, so someone will always want to do it.

Despite that, an independent, unagendered (Sp) viewpoint, delivered without fear, is always interesting and of value, even when wrong. This is how commentators like Marc Faber and Nouriel Roubini have survived for so long despite being so repetitively wrong, because they are independent, free speakers and, of course, just occasionally, when the market tips over, they can claim the high ground and shout “I told you so”. Someone has to sit at the bearish end of the market’s bell curve of opinion and someone has to provide the devil’s viewpoint. It is a good space to occupy because there are not a lot of people there, so you stand out more easily.

But you can’t sit there if you’re trying to sell a financial product in the finance industry, Boom sells, not Gloom and Doom, meaning that financial market negativity is for people selling subscriptions not financial products. Which is why the bears are in the minority, because it serves nobody’s commercial purpose unless you are selling a newsletter that gorges on fear.

But this week one of the major brokers, an institution permanently prone to optimism for commercial purposes, interestingly crossed the line. The mainstream getting bearish is another sign, when the institutions that are commercially biased to promote greed, start to move towards fear.

This week Morgan Stanley’s Chief US equity strategist writes that the market is in the midst of a “rolling bear market” across all global risk assets caused by the drain in liquidity (the end of quantitative easing) and peaking growth (ending of the Trump tax sugar hit for corporate earnings). He says that “with growth, tech and discretionary stocks, having now begun to underperform, the S&P 500, the final holdout of the ‘rolling bear market’, will eventually succumb, and probably soon”. The implication is that “the rebound last week was nothing but a dead cat bounce and the correction is not done yet”.

In times of flux when volatility is high and everybody fears what will happen next, the herd can obsess over the irrelevant and it is doing so at the moment. The focus is on the S&P 500 which has dropped below the 200-day moving average (again). Morgan Stanley says “We look for confirmation (of a bear market) with a definitive break of the S&P 500 through its 200 day moving average”. Below the 200 day moving average is another sign.

Here is the chart of the S&P 500 showing the 200 day moving average in red.

As an aside when the 50 day moving average (in blue) crosses through the 200 day moving average (in red) it is described over-sensationally as a “Death Cross” (it is called a Golden Cross when it happens in the other direction). These crossings are seen as significant but the reality is that if you traded the market by selling on a Death Cross and buying on a Golden Cross you would be buying and selling much much too late. But it is still technically interesting to watch, and as you can see in the chart above the gap is now closing.


Another bear market indicator is something called the Hindenburg Omen. It is a technical indicator that compares the number of 52 week highs to the number of 52-week lows on the New York Stock Exchange and purports to predict the likelihood of a market crash. It was named after Germany’s Hindenburg airship that crashed in 1937 and ended passenger-carrying airships. The Hindenberg Omen Indicator was developed by a chap called Jim Miekka, a blind mathematician.

The Hindenburg Omen is based on the idea that normal market conditions entail most securities making 52-week highs not 52-week lows. But if both are occurring at the same time, the Hindenburg Omen predicts that the bull market is ending. The signal typically occurs in an uptrend. There is a formula to the indicator but on the face of it, it is saying that more stocks are hitting new 52 week lows than highs which is a useful piece of information and if you chart that ratio you might get a heads up that the trend is about to turn.

Hindenburg Omen criteria - can be used for any equity market:

  1. The 10-week moving average of the exchange's composite index (S&P 500) must be rising.
  2. The number of stocks making new 52-week highs and lows must both exceed 2.2 percent of the total issues traded in an exchange.
  3. The McClellan oscillator — a measure of market breadth based on advancing and declining stocks — must be negative that day.
  4. New 52-week highs in an exchange must be less than or equal to twice the new 52-week lows in an exchange.

As a rule, the shorter the time-frame in which the conditions listed above occur, and the greater the number of conditions observed in that time frame, the stronger the 'effect'. If several—but not all—of the conditions are repeatedly observed within a few weeks, that is a stronger indicator than all of the conditions observed just once during a 30-day period.

Why mention all this? Because all the criteria were met on September 11 on the New York Stock Exchange. This is a chart of the Hindenburg Omen Indicator) over Different Time Periods Compared to the S&P 500. The Red (12 Month) indicator is of most relevance and as you can see it has hit the highest level since the GFC.

Does it matter? Not really. The Hindenburg Omen is not a great indicator, it has a record of false alarms, but more interestingly perhaps is the fact that it always triggers before any major market sell-off as it did in 1987 and 2008. Not every Hindenburg Omen signals a market top, but every market top sees the Hindenburg Omen triggered. It is just another sign.

The signs, they are agathering.

Tomorrow – What to do in a bear market (short version – cash is king!)

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