Uncertainty over the US election and now the Fiscal Cliff has caused investors to flee the equity markets and go into “risk off” mode. As a result many are asking whether the recent selloff in US stocks is the beginning of a new bear market.
The beginning of a new bear market?
Between the year 2000 and 2007 the correlation between the balance sheet of the Federal Reserve and the direction of the S&P 500 was less than 20%. Since 2007 however, the correlation has been 86% giving renewed meaning to the old stock market adage “Don’t fight the Fed”.
However the Fed’s most recent round of Quantitative Easing, so called QE3, has failed to deliver the kind of equity market rally seen in the wake of previous Federal Reserve stimulus attempts.
Uncertainty over the outcome of the US election and concern over the resolution of the Fiscal Cliff, has caused investors to flee the equity markets in favour of government bonds. And with markets now firmly in “risk off” mode, many are asking themselves if the 6.4% decline in the S&P 500 since mid September is the beginning of a new bear market.
Stan Weinstein, a veteran in the world of technical analysis, believes it is.
During his 47 year investment career Mr Weinstein has developed a straightforward form of technical analysis he calls Stage Analysis. Explained in detail in his 1988 book Secrets for Profit in Bull and Bear Markets, Stage Analysis is a simplified approach to buying and selling shares that aims to buy shares which are in “breakout mode”.
The approach identifies four primary stages that stocks go through. The four stages are:
Stage 1: A base-building stage in which some investors begin accumulating. Culminates in a breakout.
Stage 2: An advancing stage which is an ideal time to buy, as long as you catch the move early.
Stage 3: A topping stage in which investors should begin to reduce their positions.
Stage 4: A declining stage in which investors should close their long positions and consider going short.
Chart of Stan Weinstein’s Stage Analysis (Click on the chart for a larger version)
The Stage Analysis system is based on weekly prices and uses a 30-week (150-day) simple moving average. A breakout about the 30-week moving average helps confirm that stage 2 has begun, while a break below it helps identify a topping process and the transition into stage 4.
Mr Weinstein, who is the editor and publisher of the “Global Trend Alert,” an advisory service newsletter for institutional investors, put out a short-term sell signal in mid September and by mid October he felt that the US stock market was in a Stage 3 top. And just last week he confirmed that “we have now entered Stage 4”.
According to his analysis, both the long-term picture and the intermediate-term picture are negative. Mr Weinstein likes to use the phrase “don’t let the tail wag the dog”, meaning that investors shouldn’t get too hung-up on what the market might do in the short-term. He acknowledges that the market is oversold in the short-term but in a recent interview he made the point that “short-term is the least important trend” and that it is the overall picture that matters.
He also highlighted the fact that “when you’re in the early stages of a new bear market, such as I feel we are, everything is not initially A to Z bearish. You shouldn’t talk in monolithic terms.” There are still some companies that Mr Weinstein feels are “ok” however there are plenty of others that have been in their own “private bear market” for some time.
“The ones that were clearly bearish were the glamour stocks. That was the canary in the mine… even though the blue chip averages made new bull market highs in September, my glamour average topped out all the way back in late March.”
Mr Weinstein makes the point that it is the glamour stocks that typically lead on both the up and the downside, and this is exactly what we are seeing with stock such as LinkedIn and Apple.
“I can only give you probabilities, and the probabilities are that I expect it [the US market] to be lower 4-6 months from now.”
As the chart of the S&P 500 index below shows, the value of the 500 largest American companies peaked on 14 September at 1,474.51. Since then the index has fallen to 1,380.03, a decline of 6.4%. However LinkedIn is down 21.3% from its peak, while Apple is down 23.2% which means they are both technically in a bear market.
An 18 month chart of the S&P 500 index (Click on the chart for a larger version)
Charts courtesy of stockcharts.com
The next chart (below) shows the FTSE 100 index which is only down 2.8% from its September peak of 5,932.62.
An 18 month chart of the FTSE 100 index (Click on the chart for a larger version)
Charts courtesy of stockcharts.com
Typically there is a very strong correlation between the S&P 500 and the FTSE 100 index, however the UK market is currently holding up much better than that of the US, which likely has to do with the recent strength in the US dollar.
It’s worth noting that the VIX volatility index is still only 16.89 which is well below the June high of 27.73 and the two spikes in 2011 of over 45.
“There’s no way of knowing if this will be a baby bear market, if it will last 6 months or 2 years.” Mr Weinstein also stated recently that this is “one of the most challenging markets in my 47 year investment career”. His advice is to stay disciplined and focus on individual companies, not markets or market sectors.
The bottom line
Until the Fiscal Cliff is resolved, further downside volatility is likely and this is certainly a time for investor caution. With this in mind we have sold our holdings of IBM, Google and Potash Corp. We have also reduced our holdings of McDonald’s and Coca-Cola.
Although we are currently bearish on what Mr Weinstein refers to as the “glamour stocks”, we remain bullish on the rest of the 247Bull Portfolio.
The US central bank and other central banks around the world remain resolute in their commitment to Quantitative Easing (QE) in order to counter the forces of deflation. This continues to provide a bullish environment for precious metals and their related equities many of which are now paying decent dividends. Gold Resource Corporation, for example, is paying a monthly dividend of 4.86%.
It is our expectation that upon the expiry of the Fed’s Operation Twist programme at the end of 2012, we will see further asset purchases from the central bank, which, along with the resolution of the Fiscal Cliff, should begin to restore investor confidence and flip the markets back into “risk on” mode.