As I begin to write this I'm reading "Consumer Confidence Nearly Crashes" tick across my news wire. Not surprising as we saw the S&P 500 drop over -16%, the Dow -14% and Nasdaq -17.24% in one month (7/7-8/8)! Over the last year we have written many times about the cycles that the markets have gone through historically. The grander, "Secular" trends, tend to be long periods of sideways to downward trending markets that overshadow the shorter, 2-5 year, "Cyclical" cycles that occur. As of today the S&P 500 has returned -8% since 2000!
Bear Market
We have mentioned in past updates that we believe we are in the Cyclical cycle that began after the 2008 bear market. We had a very nice bull phase of the cycle, an intermediate correction last year and now we do believe we are entering the bear phase of the cycle. We look at many indicators that help guide us to our conclusions but as any professional investor understands, what happens in the future will or will not confirm your actions in the present. Over the past month we have reduced our market exposure for our clients significantly within our equity portfolios to protect capital. Our options accounts, as many know, are designed to make money in up, down and sideways markets and have been positioned to reap the rewards of the down market.
Indicators
We look at many different indicators during our research process to help us understand risk levels in the markets. They include technical, fundamental and sentiment or behavioral indicators. On August 15th the S&P 500 created what is called a "Death Cross", meaning the 50-day moving average dropped below the 200-day moving average producing a very bearish signal. Along with this we saw a spike in stocks hitting new lows. When this gets over 40%, which it was, it is another bearish signal. Fundamental indicators continue to provide concern other than the strong corporate earnings that we have been seeing. Europe's debt problems, high unemployment rates in the U.S., continued deflation of housing prices and the Federal Reserves exhaustion of its tools to stimulate the economy makes us feel like we are bobbing in the ocean letting the currents take us where they may! An interesting statistic is that each time U.S. GDP has dropped below 2% a recession in the economy has occurred. Last Friday GDP came in at 1%. Could we be in the midst of the double dip recession we have all been reading about? Only time will tell.
Bear Market Behavior
The bear phase of a cycle, in most cases, is a process, not a clean down segment and then recovery. Volatility, which we have seen spike recently, is par for the course with large daily moves up and down with no trend being established. Another phrase we use is "sucker rallies" which have almost always been present in bear markets during the bottoming process. They build enough confidence for investors to feel like they are missing out in gains, sucks them into the markets, and slams them with losses when it reverses. Although some of these rallies can move up significantly, we do not like to participate in them as we have seen many investors, including professionals, get caught up in these and take substantial losses. Our stance at this point is to be patience with our equity portfolios and opportunistic within our options portfolios, with protection of our client's capital as the overriding goal. We will let our indicators guide us back into the market just as they guided us out.
The opinions are strictly those of the author(s) and are provided for informational purposes only. No investment should be made as a result of this article without your personal due diligence and research, and with the counsel of an investment professional.
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