The Bear Market Hook

Has a Bear Market in Stocks Begun?

The stock market correction into late December was of approximately the same size as the mid 2015/early 2016 twin downturns, so this is not an idle question. Moreover, many bears seem quite confident lately from an anecdotal perspective, which may invite a continuation of the recent upward correction. That said, there is not much confirmation of said confidence in data that can be quantified.

Our proposed bearish wave count for the S&P 500 Index, which could easily be completely wrong, so take with a big grain of salt. Let us just note here that this chart looks bearish regardless of the wave labels. The latter are mainly meant to serve as an orientation aid (i.e., if something very different from the expected fractal shape develops, we would know that this interpretation is wrong; on the other hand, if the expected shape does develop, we could be reasonably confident of where short term turning points are likely to occur and would have further confirmation that a large scale bear market has begun).

Obviously, our personal impressions of anecdotal sentiment alone are a bit of a thin reed to hang a forecast on – and as noted, these observations are at least partly contradicted by hard data, such as e.g. put-call ratios:

CBOE equity put-call ratio and the CBOE total (equity and index combined) put-call ratio – in the third week of December, option punters finally showed some fear, even though the one-day peak in equity options remained below the early 2016 spike high. Remarkably though, traders are apparently still extremely eager to catch falling knives at the first hint of a turnaround, as the equity P/C ratio fell to its lowest one-day reading in almost 5 years just four trading days later!

Along similar lines, speculators in E-mini futures doubled their net long exposure in a mere two weeks to more than 350,000 contracts (large and small speculators combined) and Rydex bear assets remain 50% below the level they reached in early 2016 (which in turn was also quite low compared to historical readings). It is fair to say that the willingness to believe remains quite strong.

Even so, given that all of this happened so close to and around the holidays, it is hard to say how meaningful it is. It is easy to come up with arguments supporting a more positive short term scenario than that suggested by our wave count; for instance, the new highs/new lows percent index (NHNLP) for the SPX did finally decline well into oversold territory (it bounced back to the zero line immediately thereafter).

S&P 500 NH-NL-Percent Index: finally a drop into severely oversold territory, followed by a swift bounce back to the zero line. In the past, such drops have ended corrections – but that was during the bull market. In a bear market the goal posts are likely to shift. Unfortunately we cannot say what happened in past bear markets, as this indicator is only available since 2010.

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Disclosure: None.

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