Bear Markets & Market Bottoms

2022 has been a brutal year for investors. Presently, the S&P 500 is down over 16% Year-To-Date (YTD), the Dow is down 12% YTD, the NASDAQ is down an astounding 25% and the Russell 2000 small capitalization index is down 19%. The devastation has been widespread, with a high number of stocks down over 50%.

Due to this, the Nasdaq Composite, S&P 500 Growth (SPYG) and Russell 2000 (All and Growth) segments of the market have confirmed their bear market status. The O’Neil methodology tends to use -25% from highs as the threshold for a bear market. Taking the commonly used -20% from highs, the S&P 500 and Russell 2000 Value have also reached the threshold. Only S&P 500 Value and Dow Industrials have not.

In our January 28, 2022 Forbes article, we noted that after two consecutive failed Follow-Through Days (FTDs)*, triggered by an undercut of prior established lows, historically (using the S&P 500 since 1970) there has been an extended bear market over 70% of the time. Below are the S&P 500 bear market statistics for the past 50+ years.

The following are the weekly charts for each of the seven bear markets, with all FTDs highlighted on each. Note, a distribution day, within the first five trading sessions after the market has a FTD, has led to a failure of the FTD 70% of the time. Also note, undercutting the rally day from the FTD implies a 95% failure rate. This has already occurred for the May 17, 2022 FTD.

In addition, we want to illustrate the following points. First, the average number of FTDs before a bear market turn is 5. If the current FTD from May 17, 2022 fails, this would only be the 3^rd failure of this bear market. Second, in the stagflation market of 1973-74, characterized by rising inflation and declining economic growth, there were a shocking 9 failed FTDs. Third, the bear market in 1987 was for an extremely short time period. The current bear market is already more than twice as long as the 56 days it took to bottom in 1987. With regard to 1987 and the COVID bear market of 2020, the first FTD worked and the market never looked back. Obviously, that V bottom in stock prices in 1987 is not being replicated this time. In general, while we feel the stock market may make its absolute low for the cycle in 2022, it is unlikely to have the rapid recovery experienced in the second half of 2020. Given the issues with interest rates and inflation, the next recovery may be more gradual and require patience. We remain hopeful that, because major damage has already been done in hyper-growth areas of the market and the S&P 5500 remains ‘only’ 20% off highs (after 135 days), it may stop short of reaching the average bear market profile (-20% over 473 days).

1) 1/11/1973 to 10/4/1974

2) 9/22/1976 to 3/1/1978

3) 11/26/1980 to 8/9/1982

4) 8/5/1987 to 10/20/1987

5) 3/24/2000 to 10/10/2002

6) 10/11/2007 to 3/6/2009

7) 2/19/2020 to 3/23/2020

In the current market, we see many similarities to the technology-led 2000-2002 bear market. Namely, this market began with a combination of the following:

· A high growth stock/valuation bubble followed by collapse.

· Higher and rising interest rates due to tightening by the Federal Reserve.

· Value/commodity group leadership.

Therefore, we think it is relevant to look at the Nasdaq during that time period in relation to hyper-growth now, as a potential leading indicator of how a bottoming process could occur.

Nasdaq 2000-2002

Ark Innovation 2020-current

The ARKK Innovation ETF provides an additional view of technology stock-related performance in the current bear market.

The above comparison assumes we have just exited the third major leg lower in the ARKK ETF. Post the third-leg lower in the Nasdaq, it had a significant bear market rally. However, there were still two significant declines ahead, including a previously mentioned 47% drop in the final leg down.

An up-close view of the Nasdaq bear market rally after the third leg lower is shown below.

As of May 17, 2022, the ARKK ETF is four days off the lows, which would make it eligible for a FTD. Although we do not track ETFs for FTDs typically, we think it would be relevant in this case. Assuming ARKK does post a FTD and retakes the 21-DMA, similar to the Nasdaq in mid-2021, it could have significant upside in a rally. The 50-DMA is 30% higher and the 100-DMA (where the Nasdaq rallied to in 2001) is 53% higher. If this occurred, it may simply be a rally in a longer bear market, but we do think it would be tradeable.

The larger indices did post a FTD on May 17, 2022, on day four from recent lows.

· S&P 500: first resistance is the 21-DMA,then underside of prior support-turned resistance near 4,150, then the 50-DMA just above 4,300.

· Nasdaq: first resistance is the 21-DMA at 13,320, then underside of support-turned resistance near 12,550, then the 50-DMA at 13,167.

· Timing coincides with an extreme oversold reading on the bull/bear indicator.

Oversold areas will surely lead should the rally resume. Many stocks are down 80-90% from their highs and overdue for a technical bounce. These include (tickers): NKLA, SFIX, UPST, FSLY, PTON, STNE, AI, QS, AFRM, CGC, ZM, SPCE, CVNA, LMND, RIOT, FVRR, TDOC, HOOD, FTCH, RDFN, BYND, RIVN, LSPD, ASAN, GH and COIN.

Leadership areas over the longer-term, which we would suggest focusing on, include the Energy sector, driven by Oil and Natural Gas, Basic Resources, Packaging, Health Care Services, Consumer Staples, and Technology Hardware. Stocks of interest include (tickers): CF, MOS, XOM, CVX, DVN, HAL, ALB, TECK, LTHM, SLVM, HRL, IRM, UNH, AVGO, CC, BCC, MAT, ATKR, MRK, PAG, AZPN, SMCI, NOC, LNTH, CYXT, ACHC, BECN, OPCH, FCN and MCK.

While a FTD does suggest increasing risk exposure to equities, at the present time, we prefer to move cautiously, citing the prior bear market examples and the fact that the low of the FTD has already been violated. As a result, we suspect we have not made the ultimate low for this bear market cycle. We would urge investors to stay patient until there are technical signals that a clear market bottom has been formed.

Co-author statement:

Kenley Scott, Research Analyst, Director, Global Equity Research, William O’Neil + Co., made significant contributions to the data compilation, analysis, and writing for this article.

Disclosure:

No part of the authors’ compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.