Uncategorized, Weekly Update

Behind the New High Headlines? A Stealth Bear Market.

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Published November 1, 2019


In the parlance of technical analysis there are two possible explanations for major leaps upward in the stock market. The market is either beginning a new uptrend – a change in market character and trend called an “initiation climax”; or the last gasp of a tired uptrend where sellers have given up and the late buyers rule the day – an “exhaustion climax”.

Here are the initiation and exhaustion climaxes of the most recent global market rally in 2016-2017 (circled):

Initiation and exhaustion climaxes

January 2018 was a stellar month with stocks ripping higher on little new information – just a buying frenzy that pushed stocks well above their trendlines. Since then, some have argued the stock market globally has been in a bear market, a “stealth” bear market. It is considered “stealth” because some U.S. market averages have hit new highs during this time. However, you can see that it is only this month (far right of the chart), after an almost two-year long period of going nowhere, that stocks globally have managed to begin a possible new push upward. During this two-year malaise, bonds have been outperforming stocks as shown below:

Last two-year, bonds have been outperforming stocks

This backdrop brings us to a recent article in the Wall Street Journal discussing the “stealth” bear market that has been going on during these past two years, tracking the beginning of this “stealth” bear to the exhaustion climax described above.

Herewith is the article by James Mackintosh from October 22nd:

“Could we be in a stealth bear market? On the face of it, the question is bizarre: A bear market is usually defined as a 20% fall from a peak, but the S&P 500 is just 1% off its all-time high. If you hold the index, you would laugh at the idea that this is anything other than a bull market, albeit a rather slow one.

Yet almost every other measure suggests a bear market started last year. Dig into the S&P 500, and it is sending a deeply downbeat message, too.
If stock markets go into decline, historians will date the global bear market from Jan. 26, 2018, just before shares were rocked by a volatility shock. In dollar terms, German stocks and emerging markets are down 19% since then; the eurozone and the Brexit-challenged U.K. are down 14%, while Japan is off about 5%.

The U.S. economy has been performing far better, and so have its big stocks. But most investors in U.S. equities have had a pretty poor experience since January 2018, as the market was held up by a small number of large stocks. Even the S&P 500 is up just 4%, less than one would have earned just in coupons on 10-year Treasurys held for the 21 months since then. Add in the capital gain, and bond investors who rolled their investment into every benchmark 10-year Treasury issue since then would be up a whopping 13%. Relative to bonds, there is a bear market building up even in big U.S. stocks.

Investors who picked smaller companies have had a truly miserable time, as the S&P gains all came from its largest members. On an equal-weighted basis the index is up just 1%, and the flawed Dow Jones Industrial Average is up 3.7%.

Change since Jan 26, 2018

Meanwhile the small-stock Russell 2000 index is down 3.6% from last January through Monday. By contrast, the Russell Top 50 Mega Cap index is up 5% over the same period.

“There’s quite a lot of evidence now that the bear market actually started in January 2018,” said Ian Harnett, chief investment strategist at Absolute Strategy Research.

It isn’t just that most stocks are down. Investors are miserable, too. Pretty much every measure of sentiment peaked early last year and has since plunged. Private investors were then the most bullish they had been since 2010, according to the American Association of Individual Investors, and only 16% reported they were bearish. Investment newsletters hadn’t been so bullish since 1986, according to Investors Intelligence.

Wall Street professionals were equally positive. More than four in five new analyst recommendations on S&P 500 stocks were upgrades in January 2018, the highest in Refinitiv data going back to 1985. Two-thirds are now downgrades as profit concerns grow. Chief executive officers’ confidence in last year’s first quarter was close to the post-crisis high reached after President Trump was elected. Since then it has plunged to where it stood as the last recession was ending in 2009. Derivatives traders were buying call options designed to profit from rising markets rather than put options that aim to protect against market falls. Now the two are much more balanced, according to Chicago Board of Exchange (CBOE) data.

The lack of exuberance is reflected within the S&P. Investors have been buying sectors that are most able to ride out a weak economy and are avoiding those that are most exposed to economic growth. The industrials, financials, energy and materials sectors are all down since January 2018, reflecting economic weakness.

Many investors say they are still buying U.S. stocks because of “TINA”: There is no alternative. With the 10-year Treasury yielding just 1.8%, stocks with rock-solid dividends or offering growth independent of the economic outlook hold appeal. Sectors such as utilities that are treated as bond proxies have done well as yields have come down.

The No-Growth Portfolio

Meanwhile, stocks with a long record of dividend growth have beaten even the megacaps, with the S&P 500 Dividend Aristocrats index returning nearly 12% including dividends since global equities peaked in January 2018.

What has to happen for the stealth bear market to turn into a real bear market? A U.S. recession is the most obvious reason to buy even low-yielding safe assets, as investors switch from seeking a return ON their investments to worrying about the return OF their investments.

Faced with falling profits, dividend cuts and highly leveraged listed companies, fear of a recession will show there is an alternative, just as it has elsewhere. Negative bond yields in Europe and zero yields in Japan haven’t created a TINA-like rush for stocks among investors who want safety.

For the moment, the U.S. economy appears to be growing slowly rather than facing imminent recession, although recessions are notoriously hard to predict. I remain hopeful that U.S. growth will continue, a U.S.-China trade deal will be concluded, and the prospects of a sneaky bear coming out of the shadows to ravage stocks will recede. With investors cautious, improved geopolitics and renewed growth could lead to a big bounce. But this remains a hope, and it would be foolish to ignore the signs of serious trouble already visible in the markets.”

Market Update

Stocks kicked off the week with a +0.6% gain as optimism on China trade negotiations and a big defense contract win for Microsoft (MSFT) kept investors in a buying mood. Tuesday found markets running in place with investors looking to the mid-week meeting of the Federal Reserve. Strength in pharma companies Merck (MRK) and Pfizer (PFE) on good earnings were offset a bit by some weakness in Alphabet (GOOG) on a slightly disappointing report. Wednesday brought the Fed’s expected interest rate cut leaving stocks higher by +0.3% with investors awaiting Apple’s report after the close. Those earnings cheered investors pushing Apple (AAPL) higher Thursday. However, the company’s rise was more than offset by cautious words from China’s trade officials about the possibility of finding a long-term trade deal. Stocks slid only -0.3% however. Friday brought a stronger open and a record high for the stock market, at least the large-cap indexes. A solid monthly jobs report helped stocks rise +1% to begin the month of November. Investors have responded positively to corporate earnings that have come in better than feared while economic data offers mixed signals.

Stocks posted a fourth straight weekly gain to push into new high territory. The S&P 500 (SPY) rose +1.51% while the Nasdaq 100 (QQQ) added +1.65%. Small-cap stocks (IWM) rose +2.00% to the upper limit of their year-long trading range.

Warm wishes and until next week.