There Already Was a Bear Market

Posted On June 20, 2016 1:01 pm

Rather than spend time trying to label the current market, try figuring out what it will be in the future.

Since 1970, the S&P 500 has on average made a new all-time high every 38 days. It’s now been 282 days and counting since this has happened. The only longer periods were during brutal bear markets of the financial crisis, the dot.com bust and the modern day worst, 1,983 days stretching from 1974 to 1980.

But by the more traditional measure, in which it takes the 20% decline in the major indices to register a bear market, this past year has come nowhere near. During the steepest declines during August 2015 and January 2016, the S&P 500 Index sold off 15% each time. A correction to be sure, but by no means a bear market. These two seemingly contradictory measures both illustrates and obfuscates the pain and frustration felt by investors over the past year.

In fact, if you just look at headline number the market as the three major indices, the S&P 500, the Nasdaq Composite and the Russell 2000 have not only held within a 15% range, but are all essentially where they were 12 and 16 months ago.

NYSE Chart 6.20.16

But this does not tell the story of all the turmoil underneath the surface. Since the S&P 500 last made a new all-time high, many areas of the market have been put through the ringer.

The destruction across the energy industry was well documented and widely known. But there actually were rolling bear markets that hit all sectors and nearly all stocks at some point. Even the FANG stocks eventually succumbed to 20% declines – shares of Apple (AAPL) were down as much as 34% and have barely recovered as they remain some 30% below the 52-week high.

Below shows  the pain inflicted upon different sectors and geographies. The highlight shows the average stock fell nearly 35% at some point during the past 12 months.

Bear table graphic highlight 6.20.16

The big question going forward is, does this long period of rolling bear markets create a situation in which the overall broader market can regroup and begin a new bull market? Or does the continued failure to move to new highs doom stocks to enter a true bear market with the major indices declining 20% or more?

Actually that may be the wrong question when we consider that most of the time things are not bottoming or topping but just moving in the middle. So rather than spend time trying to label the current market, let’s try to figure out where the next opportunity lies. Most of the time stocks and the broader market are churning or trending. Most of the time, there is no inflection point at hand – these are rare occurrences.  But when they do occur it can be very profitable.

Buy the Fear

One of the more reliable tactics, not just through the past but historically, has been to buy stocks when fear spikes. When volatility, as measured by the CBOE S&P 500 Volatility Index or VIX, it ultimately leads to two bullish forces; it means not only is there a “safety net” in place cushioning further declines but also most of the selling has already occurred. We just witnessed such a crescendo of fear this past week over concern about Great Britain leaving the Eurozone.

The VIX spiked nearly 45% over just three days, while the S&P 500 fell just 2%. This was the largest move in the VIX relative to S&P in over 27 years. Such a spike in fear has been a reliable buy signal not just for the short-term pop, such as the near 2% gain we saw on Monday, but bodes well for the weeks and months to come.

As the table below shows when the VIX spikes while the S&P is still trading above its 200 day moving average solid gains usually follow.

VIX vs. SPY chart 6.20.16

While last week’s hump in VIX was slightly less than 50%, it came on a relatively small decline meaning the fear was rampant without a true reason. When the markets act irrationally it’s usually a good time to step and scoop up stocks. Just don’t become complacent and overstay your welcome, because you never know when the next bear market could come rolling along.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.