Bear Market - Another Terrible Day Of Selling

In the short term, I was very wrong to be bullish as of Friday’s close. Stocks fell sharply on Monday, which makes them even more oversold.

It’s almost as if the market is doing whatever it takes to get the Fed to not hike rates on Wednesday. Volatility and lateness of the cycle make this the most important Fed meeting in years.

Bear  Market - New 2018 Low

S&P 500 was down 2.08%. That’s not close to the worst day in this correction. But it’s important because the S&P 500 fell below the February low, marking the lowest point in 2018. The 14 day S&P 500 is at 36.93 which signals the market is close to being oversold, but it’s not there yet.

CNN fear and greed index weirdly increased from 8 to 10. Volatility index is neutral in this rating system because the 50 day moving average has increased so much that the current elevated level has become the new normal. VIX was up 13.36% to 24.52. That’s certainly not normal for a bull market.

Bear  Market - Start Of A Bear Market? Small Caps Are There

Some bearish traders think a bear market is already here. Yet there’s little evidence of a recession. Also, S&P 500’s forward PE has fallen sharply, and sentiment is horrible. 55% of S&P 500 stocks are down over 20% from their 52-week highs and 44% are down at least 25%.

Keep in mind, figuring out whether this is a bear market doesn’t matter nearly as much as where stocks are headed. We leave the definitions to the historians. Instead of a bullish investor claiming this isn’t a bear market, they can say we’re in one and it’s almost over based on the carnage.

The chart below shows the percentage the 50 largest companies are below their 52-week lows.

You can see the FAANG names are all down more than 20%. Merrill Lynch sentiment poll which said the FAANG stocks were the most over-owned group in the summer was correct. It correctly advised investors to sell these names. Keep that in mind when I review this survey in a subsequent article.

Bear  Market - Russell 2000 is already down over 20% from its record high which puts it in bear market territory. 

Since the bottom of the financial crisis, the Russell 2000 has fallen over 20% 2 other times. It fell 29.6% in 2011 and 26.4% in 2015-2016.

Small caps are more volatile than large caps. They are more affected by weak financial conditions as they have high debt levels. Since the Russell 2000 is down 20.8%, it’s fair to say if you think this is an economic slowdown and not a recession, there’s not much downside left. It could be over 2/3rds through its decline if it follows the last two bear markets.

The chart below shows the average stock market performance following corrections and bear markets.

As you can see, this volatility looks more like a bear market than a correction. In fact, the market is underperforming the average bear cycle because it has fallen so quickly.

This chart shouldn’t be enough to make you start buying stocks. It just gives context to the discussion about whether this is a correction or a bear market. I’m bullish in the short term and acknowledge that this selling has been severe.

Bear  Market - Utilities Shockingly Crater

As you can see from the table below, the S&P 500 is about to have its worst December since the Great Depression.

Keep in mind, that this table doesn’t mean a Great Depression is coming. There is seasonally positive action at the end of the year which is why there haven’t been that many bad Decembers.

With such volatility occurring, you would think the utilities did great on Monday.

However, they cratered 3.27%, which was the 2nd worst sector performance on the day.

Maybe investors realized they had too much multiple expansion. They should soon realize the overall market has seen too much multiple contraction.

The worst sector was real estate which fell 3.72%. Even though utilities and real estate like falling rates, they fell along with rates. Every sector fell.

The best sector was the financials which only fell 0.97%. Financials had been underperforming recently. They are finally recognizing the steepening yield curve.

Bear  Market - Buy The Fear

Monday’s market feels even worse than Friday’s market. But it’s an even better buying opportunity because stocks are even more oversold.

As you can see from the table below, when the investor sentiment reading is in the bottom 5% like it is now, returns average 4.2% in the next 3 months.

Even if this is a bear market, stocks should rebound in the next few months because of the extreme pessimism.

Bear  Market - Falling Rates & Rate Hike Odds

The 10-year yield is 2.85% and the 2-year yield is 2.69%. Both are below the Fed’s current guidance for 3 more hikes in 2019 after the one on Wednesday.

The good news is difference between the 10-year yield and the 2-year yield is 16 basis points which is a 5 point increase from the cycle low a few days ago.

Because of the recent decline in stocks, the Fed funds futures market now doesn’t expect any hikes in 2019 if the Fed hikes in December.

That hike isn’t a guarantee as the CME Fed watch tool shows there is a 68% chance of a hike. My prognostication, which I have wavered on, that the Fed won’t hike if the S&P 500 falls below the February low is being tested.

One point to consider is the odds may be slightly higher than this tool suggests because the Fed is only going to hike rates 20 basis points if it does hike them.

Interestingly, since 1980 only 2 of the Fed’s 76 rate hikes have occurred when the S&P 500 is down in the last 3 months, 6 months, and 12 months. If the Fed doesn’t hike, stocks will rally sharply.

If the Fed hikes, stocks probably won’t move. However, if the Fed hikes and guides for 2 or 3 more hikes in 2019, stocks will likely fall.