Reasons to Stay Bearish

2016 is proving to be anything but boring so far. U.S equity markets rang in the new year with a significant sell-off that has left the S&P 500 roughly 10% off its highs. This recent volatility has many debating whether we are experiencing a mere market correction within a long-term bull market or the end of the bull market. Is this the beginning of a cyclical bear market for stocks? Based on the technicals and current market conditions I have a bearish, risk-off outlook and personally have been taking more short positions than I ever have in the past.

The Bull Market is Getting Old

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Perhaps one of the most basic arguments favoring the bears is the average longevity of a bull market.  The data I am looking at comes from an analysis done by Mackenzie Investments (pictured above) that examined bull and bear market periods of the S&P 500 index dating back to 1956. The report shows that bull markets last an average of 4.3 years (51 months) and in that time gain an average of 153%. The current bull market has lasted almost 7 years now (83 months) and returned 206% (2016 not included.) It’s important to note that there’s much discrepancy in how analysts measure and define a bull market, but no matter how you look at it, it’s clear that the bull market investors have enjoyed since 2009, is getting long in the tooth and a cyclical bear market may be on the horizon.

The Technicals

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In my opinion, the most compelling argument favoring the bears lies in the long-term charts of the major U.S. indices.

Above is a 20 year chart of SPY, a popular ETF that tracks the S&P 500 index. A solid resistance level was formed in 2008 when the index failed to breakout above the high’s from the year 2000. The index was able to breakout above this level in 2013 and has since extended well above. Typically when price breaks out above a resistance level, this former resistance level then acts as support when price revisits it. I expect the 140-160 level that served as resistance in ‘00 and ‘08 will act as a trampoline of support once it’s tested. Unfortunately for the bulls the S&P will need to fall roughly another 20% until it reaches this key level. For anyone interested in Fibonacci patterns, one of my favorite technicians, J.C. Parets has been very vocal in pointing out that in 2015 the market reached the 161.8% fibonacci extension of the ‘07-’09 decline (In red above). He explains the importance of the 161.8% fibonacci extension in his post “Is This Why The S&P500 Stopped Going Up?”

 

Seasonality

The January Barometer is one of the most basic concepts in the study of seasonality. It states that as the S&P 500 goes in January, so goes the rest of the year. Since 1950 this indicator has accurately predicted the direction of the market 87.7% of the time! For example in January 2000 the S&P fell 5.1% and finished the year -10%. In addition, in January 2008 the S&P fell 6.1% and finished the year down 38.5%. In January of this year the S&P fell 3.4% which suggests more pain for the rest of 2016. Furthermore, Santa was a no show this year for investors expecting the famous “Santa Claus rally.” The Santa Clause rally is the tendency for stocks to rally in the last 5 trading days in December and the first 2 in January. In the past, the absence of such a rally during this period has been known to be a predictor of bear markets.

The volatility we’ve seen recently in equities is an indication of the level of uncertainty that exists among market participants. In these times of uncertainty it’s important to tune out the noisemakers and financial news media and trust only price action and historical data. Long-term charts and data show us that we may be due for a bear market and seasonality indicators suggest more pain ahead for 2016. Some financial pundits are saying this 10% decline is nothing more than a great buying opportunity, but it is important to keep in mind the presence of bearish conditions that have the potential of turning a “correction” into a recession.

As always, feel free to email me with any questions or comments Pdunuwila@gmail.com