Thursday, October 16, 2014

bear market

During the past week both the Dow and the S&P 500 (top two charts) dropped below their 200 day moving averages (red lines). While the New York Stock Exchange advance-decline line is holding above its 200 day average I don't think it will stay above it much longer. What you don't see on the Dow and S&P charts is the very heavy volume which has accompanied the moving average break. I think this is especially significant and is strong evidence that a bear market has begun.

The fact that the bull market lasted an extremely long 66 months is another reason for taking this high volume breakdown seriously as a bearish signal. More supporting evidence can be found in the fact that the Fed is ending its open-ended QE program this month. As I have pointed out in previous posts, the last two QE halts, in 2010 and again in 2011, were associated with big drops in US stock prices.

The prognosis is for a drop of 20-30% from the September highs. This would bring the S&P down into the 1400-1600 zone and the Dow down into the 12,000 - 14,000 range.

Bear markets are known for violent rallies which come out of the blue but are just temporary interruptions of the downward course of prices. I think one such rally has either begun or will soon do so from around the 1790 level in the S&P. But I think any such rally will retraces only about half the drop from the September highs before the bear market resumes.

The fourth chart from the top shows a five year history of the 5 day moving average of CBOE equity put-call ratio. You can see that the ratio is higher than it has been in two years. This is a warning that a rally is imminent but isn't much help in identifying exactly when it will begin.

The bottom chart show a 10  year history of the VIX volatility index. Very high volatility is generally associated with market low points. While the VIX is higher than at any time since 2011 you can see that it is still a fair amount below its 2010 and 2011 peaks and very far from its 2008 peak. Hopefully the VIX won't get anywhere that 2008 top in this bear market.

Both the VIX and the put-call ratio are warning that a big fast rally is likely within a few days if it hasn't aready started.


Bill said...

Carl I totally agree with your assessment of a bear market until James Bullard, the St Louis Federal Reserve Bank president, said this morning that the Fed may want to delay tapering QE This is a game changer that could cause the stock market rally to continue.

pursuitist said...

We're tracking 1998, where there was a severe drop in August to 10% Nasdaq, followed by a relief rally back up to the 5% line, followed by a second drop in October, to minus 12% Nasdaq, followed by.... On to nose bleed heights. This time around the August low is now, and the phone low will likely be late November to mid December. If one were using only 200 day Ema crosses to determine bull and bear markets.... There was a three month period in 1998 where it would have been announced bull, no bear, no bull, no bear, no BULL!

Samuel Chetty said...

I agree with pursuitist that we're in a 1998-ish scenario rather than a classic bear market. From 1920 to the present, if you exclude cyclical bulls within bear markets, and don't count isolated drops (1987, 1990, 1998, etc.) as bear markets, 66 months is not unusually long for a bull market. I am very confident that 2009 was a secular low, in which case the subsequent bull market could last up to three more years without being an outlier.

From an Elliott Wave perspective, I only find three primary waves from 2009 to the present:

Wave 1: Nov. 2008/Mar. 2009 - Feb. 2011
Wave 2: Feb. - Dec. 2011
Wave 3: Dec. 2011 - Sept. 2014

So it looks to me like this is a Wave 4. Wave 2 included a 19% drop, and Wave 4 will likely be of similar magnitude or a little milder.