The S&P has now fallen -20%, the conventional definition for a “bear market” (We define “bear markets” as 33%+ declines that last at least 1 year. 15%+ declines = “big corrections”).

Go here to understand our fundamentals-driven long term outlook.

Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are walking blindly into the future.

When will the first big rally happen?

You can notice something very interesting in our market studies recently. While the market studies are consistently medium term bullish, they have never been consistently short term bullish.

Why?

Because the stock market is selling off at a once-in-a-decade speed right now.

During such times:

1. The stock market “eventually” makes a big medium term rally. Whether that rally leads to a new all-time high or is followed by lower lows is yet to be seen.
2. The stock market can go down more in the short term.

How much more can the stock market fall in the short term?

No one knows. When the market starts panic selling (e.g. right now), the potential range for a bottom is very wide. This is why David Tepper is starting to buy some stocks right now, but he’s not max long. (David Tepper is one of the few real experts.)

In an environment like this, the worst thing to do is to go all in, guns-blazing long.

1. If you are lucky, you might catch the exact bottom.
2. If you are unlucky, the stock market might fall another -10% in 2 weeks before it makes an vicious rally.

CNBC published good piece about what 20%+ declines in the stock market look like.

Since World War II, bear markets on average have fallen 30.4 percent and have lasted 13 months, according to analysis by Goldman Sachs and CNBC. When that milestone has been hit, it took stocks an average of 21.9 months to recover.

This statistic is a little misleading, because 20%+ declines vary massively in terms of MAGNITUDE. Some declines are 20% while others are 50%.

Let’s see how much 20%+ declines need to fall before the first big rally begins.

2011

The S&P fell 19.6% before making a big retracement that almost reached 50%

The total size of the decline was 21.5%

2008

The S&P fell 20.2% before making a big retracement that almost reached 50%

The total size of the decline was 57.7%

2001 (past the -20% mark)

The S&P fell 28% before making a big retracement that almost reached 50%

The total size of the decline was 50.4%

1998 (past the 20% mark)

The S&P fell 21% before making a big retracement that almost reached 50%

The total size of the decline was 22.4%

1998 (past the 20% mark)

The S&P fell 21% before making a big retracement that almost reached 50%

The total size of the decline was 22.4%

1987 (past the 20% mark)

The S&P fell 35.9% before making a small retracement that almost reached 38.2%

The total size of the decline was 35.9%

1981 (past the 20% mark)

The S&P fell 22.3% before making a small retracement that almost reached 38.2%

The total size of the decline was 27.2%

1977 (past the 20% mark)

The S&P fell 20.3% before making a big retracement that almost made new highs

The total size of the decline was 20.3%

1973 (past the 20% mark)

The S&P fell 18% before making a 50% retracement

The total size of the decline was 49.9%

1969 (past the 20% mark)

The S&P fell 19.5% before making a 50% retracement

The total size of the decline was 37.2%

1965 (past the 20% mark)

The S&P fell 23.6% before rallying straight to new all-time highs

The total size of the decline was 23.6%

1962 (past the 20% mark)

The S&P fell 26.8% before rallying straight to new all-time highs

The total size of the decline was 29.2%

1956 (past the 20% mark)

The S&P fell 21.1% before rallying straight to new all-time highs

The total size of the decline was 21.1%

Conclusion: how much did the S&P fall before the first big rally began (regardless of whether that rally led to new highs or not)?

1. 19-25%: 10 cases
2. 25-30%: 2 cases
3. 30-35%: 0 cases
4. 35-40%: 1 case (1987)

As you can see, most cases cluster around 19-25%, with the big exception at 35% (October 1987).

Bullish Percentage Index

The S&P 500’s Bullish Percentage Index (a breadth indicator) is extremely low right now. The only other times it was this low were in October 2008 and July 2002.

Here’s what happened next to the S&P 500 when the Bullish Percentage Index fell below 13

*Data from 1996 – present

 

As you can see, while stocks could fall more in the short term, this was generally a medium term bullish sign.

*I think a 2008-style 50% crash right now is an exaggeration. The financial system was imploding in 2008 and the U.S. economy was in a massive recession. The context is very different from today.

Breadth

Other breadth indicators continue to demonstrate extremes. Only 1.2% of S&P 500 stocks are above their 50 dma right now.

Here’s what happened next to the S&P when less than 2% of its stocks were above their 50 dma.

*Data from 2001 – present

As you can see, while stocks could fall more in the short term, this was generally a medium term bullish sign.

*Part of me wonders if breadth indicators are less useful than they used to be. Thanks to the rising popularity of ETFs, breadth extremes are easier and easier to reach. E.g. when someone sells $SPY, that puts downwards pressure on all 500 stocks in the S&P.

4 days in a row

The S&P 500 is now down 4 days in a row, with each of those 4 days down at least -1.5%

Quite the panic selling.

Here’s what happened next to the S&P when it fell more than -1.5% for 4 days in a row (first case in 1 week).

*Data from 1927 – present

Interestingly enough, even in the Great Depression, this led to a 1 month rally. Outside the Great Depression, this was close the short term and medium term bottom.

Click here for yesterday’s market studies

Conclusion

Here is our discretionary market outlook:

1. For the first time since 2009, the U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward.
2. The medium term direction is still bullish  (i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration.
3. The short term is a 50/50 bet

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.