We’ve now had a 19% decline. That’s from one daily closing price to another daily closing price—9/20/2018 to 12/24/2018. On an intraday high to intraday low, it was a 20.2% decline. Is it over yet?
That’s more than a 20% decline. That’s what we learned was the definition of a bear market. Is it over yet?
Since the bottom on Christmas Eve, the S&P 500 has rallied 10.17%. That’s almost, but not quite, halfway back because of the mathematics of declines. A 20% loss takes a 12.5% recovery to return to the halfway mark.
Still, it was a big bounce. And it occurred over a shorter period than any bounce back since 2009.
That’s what Bloomberg and other financial media outlets told us on the web. But they failed to mention that in the 2000–2003 bear market this happened five times before the market finally went into long-term rally mode. And the same was true in the 2007–2008 sell-off.
Is it over yet?
As you can imagine, I do hear that question a lot. But I can’t answer that question with certainty. The market has a mind of its own on such occasions. We could head lower from here or we could rally right back above the highs made back in September.
I can relate the present market to past market history and this environment to other bear market moments.
I do know that the mere existence of the recent market bounce and big percentage daily up moves described here and in last week’s article do not provide a definitive rationale for a resumption of the rally. Such moves seem to happen at least as often on the way down from a top as they do rising from a bottom.
Since WWII, there have been 12 times when the market has fallen at least 15% within three months and then risen at least 10% in a 10-day period. In all but two of them, the S&P 500 was at a higher level a year later. The average gain was 13%.
Sounds like a good time to buy, right? I’d say “no,” but it probably is a good time to start buying. That’s what a number of our strategies have started to do.
In the past when this “decline then bounce” pattern occurred, the market actually went lower within the next week half the time. That’s right, lower lows were reached half the time after the big bounce occurred.
In investing, it is rare indeed that one can buy at the absolute bottom and sell at the ultimate top. Rather, dynamic investing often requires you to start buying before the bottom and continue after the bottom. Sometimes the first buy will occur substantially before and/or after the bottom. Many buys usually occur along the way to becoming 100% invested again.
Most of our strategies outperformed the S&P 500 on the way down in the 19.8% decline from September 24. But none of them sold at the top on that day.
Rather they gained clues from the market as it proceeded down, telegraphing the knowledge that further declines were likely. When they quit selling, some strategies were still invested a small percentage in stocks, some held no stocks, and a number were actually short or inverse the market, making gains as stocks continued to tumble.
I expect it will be the same story if stocks rally further from here. Our strategies will likely become more aggressive as they follow their time-tested methodologies on the way up, just as they reduced their exposure on the way down. But importantly, if stocks turn around and head lower once again, the reduction in equity exposure in the strategies will likely continue and the percent short may get larger.
The point is that with quantitative strategies it is not a question of being able to determine if it is “over yet”—rather, it’s knowing that whatever actions the strategies are taking, the probability, rather than the certainty, they are going in the right direction for your portfolio is likely.
The market showed strong gains this week as the S&P rose 2.5%, the NASDAQ closed up 3.5%, and the previously weak Russell 2000 Index of small-cap issues rallied 4.85%.
After the fourth-quarter decline, that sounds so good. And there are plenty of indicators suggesting that the gains since Christmas Eve are just the beginning. The indexes have been broadly positive. New highs, and the extent of both advancing issues and volume, suggest further gains.
Similarly, economic data, while soft, must still be rated as supportive. Sentiment is not at an extreme, suggesting a change. Suddenly the talk of interest-rate hikes has turned almost dovish. Federal Reserve governors have started talking in terms of slowing down the rush to raise rates, and projections of three rate hikes this year have been morphing into only one.
Earnings reporting season starts this week. Over the last three months, 65% of the earnings reported have been surprises on the upside. While this is above average, it is also below the rate in recent quarters. Similarly, it’s also the case with revenues, although to a lesser positive extent. The future earnings guidance given by reporting companies has been negative lately. However, this suggests a greater chance of positive surprises this reporting season, and that augurs well for earnings-supported price increases in stocks as the monthlong reporting plays out.
All of this is on the positive side of the ledger. Most of these data, like economic and earnings reports, are also more intermediate term.
In contrast, while the negative side of the balance sheet also has many entries, they are more immediate and likely more short term.
While interest rates have been falling, we are near support levels. The direction of rates seems likely to turn upward.
The S&P 500 has now returned to the levels at which the rally found support. What was once hard to break through to the downside becomes a barrier that is difficult to break back through to the upside.
Our Market Regime indicators continue to be somewhat split. The All-Terrain version maintains its normalcy. That is supportive of stocks. Our Volatility measure is “high and rising.” That indicates more volatility in stocks to come—although the stock portion of the measure, which also includes gold and bond volatility, is in a “high and falling” state suggestive of further gains.
Of course, stocks are overbought. They have moved higher and faster than normal and could probably use at least a pause.
Our Political Seasonal Index topped today and stays negative until January 22. It has been positive since before Christmas. (Our Political Seasonality Index is available post-login in our Solution Selector under the Domestic Tactical Equity category.)
All in all, we have a mixed picture, as seems always to be the case. The strategies are improving a bit, but they are still in a defensive posture. So, for me, in the short term, it isn’t over yet. But for those who don’t have to write a weekly newsletter and have a longer-term perspective, it is probably time to start accumulating. Speaking of newsletters, this one is over.
All the best,
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