The recent bounce in the stock market has been nice, but it tells us very little about whether it will continue…or roll over and make new lows. The biggest problem is that the recent rally is nothing more than what we usually see at the beginning of a bear market, so nobody can say that the worst is behind us.….That said, we readily admit that the recent action does NOT mean the stock market will DEFINITELY roll-back over into a important bear market. It’s just that bear markets ALWAYS see the kind of bounce we’ve seen recently…in the MIDDLE of the decline…and long before we reach the final low….and thus investors need to be careful over the coming days and weeks.
In fact, the action we are experiencing right now is almost exactly what we saw in late 2007 and early 2008! Back then, we experienced EXACTLY what we’ve seen over the past few months. After a fabulous bull market…and after a “double-top”…the S&P saw a strong decline of 18.3%. This was followed by a bounce of 12% (a 50% retracement of the sharp decline)…..The problem is that this action was then followed by a severe decline to lower-lows…and a horrible bear market.
This time around, we’ve seen a similar “double-top”…followed by a very similar initial decline (of 19.8% this time)…and then a sharp bounce which also retraced about 50% of its initial decline…just like it did in early 2008. (On top of this, the 4th quarter initial (sharp) decline had two very-short-term bounces of 6%-8% before it bottomed just below bear market territory…which is exactly what we saw back in 2007 as well. How weird is that???)
Oddly enough, the bear market of 2000-2003 got ALSO got off to a very similar start. It’s initial sell-off was 16.8%…followed by a 8.6% bounce (or a 45% retracement of the initial decline)…but then rolled back over into a horrible bear market. (The initial decline only had one bounce back in 2000…instead of two (like it did in 2007 & now), but the moves are still eerily similar.)
Having said all this, we can ALSO sight with examples of times when this kind of action was NOT followed by a bear market…and instead of rolling back over, the stock market was able to bounce-back in a more sustainable fashion…and avoid a bear market.
In 2010, a 16% initial decline was followed by a 10% bounce (50% retracement)…only to fall to a “higher-low”. That “higher-low” was followed by a nice “higher-high”…and the stock market was off to the races. We saw a very similar situation in 2011…when a 19% decline was followed by a 61.8% retracement…then another “higher-low/higher-high sequence” and the market was again off to the races.
What we are trying to say is that the recent bounce…as impressive as it has been…tells us VERY LITTLE about what is going to happen next. IT CAN GO EITHER WAY!!!.….Therefore, we’re going to have to wait to see what happens over the next few weeks to see which way things are going to go this time around.…(We want to reiterate that the next few WEEKS will be key, not just the next few days. The next 1-2% move won’t tell us much…but the next 5%-7% move should.)
We still worry that it will resolve itself the the downside. During the examples we sighted about what took place in 2010 & 2011 (when the markets bounced back), we had an historically accommodative Fed…but now we’re looking at a Fed who will be providing less liquidity to the system than they have in the past. Therefore we think the odds are high that the stock market will roll-back over and move into a bear market this time. (However, we are NOT looking for the kind of “horrible” 50% bear we saw in 2000-2002 and 2007-2009.)……..The good news is that if we’re wrong, we should know within the next few weeks.