11 February, 2018 Education

Signs of a Bull or Bear market

Signs of a Bull or Bear market?

We’ll evaluate below whether or not this past 6 weeks of market behavior is any indication of a continued bull market or coming bear market. Before we do that, let’s put the last 6 weeks in perspective.

Let’s go back to your New Year’s celebration and remember the good feeling you had about your portfolio’s performance in 2017…it was a great year! Suppose you made a resolution to take a break from financial news...you just were not going to look for 6 weeks. You now open your eyes, we are 6 weeks into the year and the S&P 500, the barometer for large U.S. stocks is off -2.0%, giving back a small fraction of the prior year’s gains. I guessing most investors would shrug their shoulders and not think much of it. That’s where we are today!

The accompanying graph shows the performance of all the major market indexes year-to-date. It’s not bad except for real estate stocks. U.S. small stocks continue to underperform as they did in 2017. International stocks, both in developed and emerging markets, are tracking very close to the U.S. markets. Although real estate is doing poorly, the two other alternative investments, gold and commodities, are holding tough in positive territory. Bonds have been a disappointment with losses similar to stocks. All and all, it’s pretty uneventful.

Of course none of us have had our eyes closed the last 6 weeks. It has been a pretty exciting ride for investors as the accompanying graph shows. Stocks came out of the gates strong during the first 4 weeks of the year surging +7.5% and have since given back all of those gains and a little more during the past 2 weeks. From peak-to-trough, the January 26th high through Thursday’s low, it’s been a -10% correction many have said is way overdue.

There are a variety of theories about what’s driven this -10% correction. The most popular seems to be concerns about signs of inflation. Inflation would push bond yields higher, possibly force the Federal Reserve to raise interest rates more than originally expected, and put downward pressure on stocks.

Another theory is that investor of all types were over-exposed to the market…owning more stocks than they should long-term. Both individuals and institutions often borrow money to increase their holdings in stocks which works great while stocks move higher and have little volatility. But when stocks turn volatile and lower, this strategy compounds losses and forces investors to liquidate positions.

When looking at the above graph and living through this exciting 6 weeks, the question is: when has this happened before? The following table shows such periods. These are periods when stocks have surged more than +7% in less than 30 days and then given back the majority or all those gains shortly thereafter.

I initially found this data very interesting but then began to wonder if it really tells any story at all! Of the 20 times when stocks surged more than +7% in less than 30 days and then quickly gave back the gains, 9 were during bear markets with 11 during bull markets. The only conclusion I get from this is that the odds are about the same for this to occur during both bull and bear markets.

The next question: when during the bull or bear market cycle did this behavior occur? For example, when there was a surge and immediate decline during bull markets, like we have just experienced, did this happen at the end of the bull market? There’s no consistency. Sometimes this happened at the very beginning of a new bull market and sometimes at the very end and nearly everywhere in between.

Market behavior like we’ve seen during the past 6 weeks feels extreme. Logic would suggest to some investors that it must be an indication of something. I suppose it is an indication of something but I’m not sure what! Based upon the past 55 years of market behavior, the ups and downs of the last 6 weeks doesn’t provide any clear indication as to whether or not the bull market is coming to an end or if it continues on for many years to come.

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