The US stock market continues its treacherous year, with the S&P 500 falling more than 20% so far and the Nasdaq Composite Index falling 28% on June 22. The sharp fall in stock prices was caused by raising interest rates and shrinking its balance sheet in an attempt to slow inflation. In addition, the economy slowed down, especially in the housing sector. The negatives were exacerbated by the war in Ukraine and uncertainty about the upcoming midterm elections. Unfortunately, we continue to believe that the latest low of this bear market cycle has not yet been reached.
While the long-term bottom may not have been reached, equity markets rarely move in a straight line. In the short term, US stock markets are moving from extremely oversold levels. History suggests that it would make sense to expect a bear market rally soon. While there are risks involved, we believe there is an opportunity for savvy investors trading in a counter-trend rally.
Below are the S&P 500 bear market stats for the past 50+ years. As one can see, the current bear market is still below the average and median loss for comparable bear markets. Perhaps more importantly, from a time perspective at 164 days, the current bear market is very short. If this bear market had an average length of time, it would be about a third.
If we examine these past bear markets, and exclude the 1987 and 2020 markets with a V-shaped recovery (2020) or no additional undercuts from the first lows (1987), we find five expanded S&P 500 bear markets since 1970. These five averaged about six failed Follow Through Days (FTDs). We define an FTD as an upward movement of 1.7% or more (historically used 1.2% or more) in the market four days or more after a new low on an increase in daily volume. The table below shows the average statistics of those failed FTDs. As one can see, the typical failed FTD has a gain of 11.8% over 26 days against the FTD. So about a month of positive performance.
However, there have been 16 bear market rallies following an FTD that lasted an average of 40 days. All returned more than 10% and the best, 5 out of 16, returned more than 20%. Given the damage done in 2022, we think an above-average rally could be in the cards this year.
An example of a solid bear market rally from the long 1973-1974 bear market was a 13% gain over 51 days. This started when the market fell about 20% from highs and after three previous failed FTDs.
One of the strongest bear rallies on record took place in the middle of the 2000-2002 bear market. After the S&P fell 38% from highs and experienced five failed FTDs, it rose 25% in 108 days and after a test of the declining 40 WMA. It then went sideways for several months before finally lowering another huge leg.
In the current bear market, the S&P 500 has so far experienced four failed FTDs on its way to hitting 25% off its highs (see *below). Bear market rallies were weaker on average compared to bear rallies history (see above). This increases our confidence that we can expect a sharper rally if the FTD materializes.
Currently we are waiting for another potential FTD. This could happen as early as Friday 24 June 2022. If it does occur, we would like to see an immediate price increase that follows to convince us of a tradable rally. In such a scenario, we also recommend gradually adding capital to the market, with the understanding that at any sign of clustered distribution one should exit trading.
Should an FTD happen, here are some areas we think are best positioned to stay ahead. The spaces can be used as a starting point to make shopping lists for a bear rally. It is always possible that the next upward move in the market will be more than a bear rally. While we doubt this will be the case, we always want to follow our technical signals and respect the action of the market.
We would also remain open to looking elsewhere in the world as several global areas seem more intriguing than the US market at the moment. These include Hong Kong/China (which appears to be bottoming out before an already protracted bear market), the UK/Canada/Norway (heavy on energy, utilities and financial markets) and Southeast Asia (long term lagging markets, commodities/financial markets). markets) heavy exposure).
Meanwhile, we would use a potential rebound in oversold areas like the one below to sell in strength, either if we own it or if we buy for a short-term gain. The resistance/overhead in these areas is too great to resolve immediately.
In short, we remain cautious. We have no indication that the market has finally bottomed out. Importantly, the US market still has no breakthroughs, normally a sign of true market strength, with only an average of 28 over the past eight weeks versus a long-term average of over 110 per week. Also, very few stocks are currently positioned in traditional technical institutions, so the breakout figure is unlikely to rise in the near term. However, we want to be alert to the opportunity to make money and a sharp rally in the bear market could provide that.
Statement by the co-author:
Kenley Scott, Research Analyst, Director, Global Equity Research, William O’Neil + Co., contributed significantly to the data collection, analysis and writing for this article.
No portion of the authors’ remuneration was, is or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates and/or their respective positions, and may at any time make purchases or sales as principal or agent of the securities referred to herein.