It’s a Bear Market in Stocks

Bear MarketOver the past year, I’ve written a few times about how stock markets, particularly the U.S. stock market, have been looking as if they may turn bearish. There are several measures that can be taken of a stock market index such as the S&P 500 to determine whether it is a bull or bear market:

  1. Whether the 50-day moving average is above or below the 200-day moving average. We got a “death cross” (the 50 crossing below the 200) in the S&P 500 Index on 5th December.

  2. Whether the price is above or below the 200-day moving average. The price has been below the 200-day moving average since 4th December.

  3. My own preferred measurement, which has historically worked very well, is very simple: is the price higher or lower than it was six months ago? It has been lower, ever since 4th December, consistently.

  4. Finally, we come to the classic definition of a bear market: whether the price has fallen by at least 20% from its high. This happened yesterday, on Christmas Eve.

Whichever way you look at it, it seems clear that based upon what has happened to stock prices in the past, the probability is that prices will fall still lower. It can be very challenging to make money shorting stocks, for a few reasons, maybe the biggest reason is that when you are short of stocks potential losses are, at least theoretically, unlimited. Yet even without shorting stocks, it can be said that now is now time to be buying stocks, unless you are a very careful and successful stock-picking value investor. Even then, the current will be against you.

Bear markets tend to fall sharply: strong and quick moves down on relatively high volatility. This is what we are seeing now: this fall of more than 20% in the value of the 500 largest public listed companies in the U.S.A. has taken place in less than 3 months! The warning signs have been there all year – a strong, sharp drop in February, followed by a slow climb to new highs on low volatility, followed then by the current strong drop on very high volatility. In fact, December alone so far has seen a drop of 16% in the value of the Index. If the month were to end like this, and this does look likely to happen, it would be worst-performing calendar month since the financial crash/crisis of October 2008 when the market closed down by about 17%. We have almost exceeded that level.

There are some reasons for optimism. The end of December often sees selloffs in stock markets for tax reasons, while January conversely tends to see buying once tax considerations are safely out of the way. Bulls are going to need all the hope they can get.

Adam is a Forex trader who has worked within financial markets for over 12 years, including 6 years with Merrill Lynch. He is certified in Fund Management and Investment Management by the U.K. Chartered Institute for Securities & Investment. Learn more from Adam in his free lessons at FX Academy.