Forbes-Bear Market Rallies

The U.S. stock market continues its treacherous year, with the S&P 500 year to date declining over 20% and the Nasdaq Composite Index posting a 28% decline as of June 22. The sharp price declines in equities were driven by the Federal Reserve raising rates and reducing its balance sheet in an attempt to slow inflation. Additionally, the economy slowed, particularly in the housing sector. The negatives were exacerbated by the war in the Ukraine and the uncertainty regarding the upcoming midterm elections. Unfortunately, we continue to believe the final low of this bear market cycle hasn’t been reached.

However, even though the long-term bottom may not have been reached, equity markets rarely move in a straight line. On a short-term basis, U.S. equity markets are coming from an extremely oversold level. History suggests that it would be logical to expect a bear market rally soon. While there is risk involved, we think there is an opportunity for nimble investors trading a countertrend rally.

Below are the S&P 500 bear market statistics for the past 50+ years. As one can see, the current bear market is still below the average and median loss for similar bear markets. Perhaps more importantly, from a time perspective at 164 days, the current bear market is very short. If this bear market were an average length of time, it would be roughly only one-third over.

If we examine these past bear markets, an exclude the 1987 and 2020 markets which had a V-shaped recovery (2020), or no additional undercuts of first lows (1987), we find five extended S&P 500 bear markets since 1970. These five averaged about six failed Follow Through Days (FTDs). We define an FTD as an upward move of 1.7% or greater (historically used 1.2% or greater) in the market, four days or more after a new low on an increase in day-to-day volume. The table below shows the average stats of those failed FTDs. As one can see, the typical failed FTD has an 11.8% gain over 26 days from the FTD. So, roughly a month of positive performance.

However, there have been 16 bear market rallies after an FTD that lasted an average of 40 days. All returned over 10% and the best, 5 of 16, returned over 20%. Given the damage that has occurred in 2022, we think an above-average rally could be in the cards in this year.

An example of a solid bear market rally from the long 1973-1974 bear market was a 13% gain over 51 days. This began when the market was down around 20% from highs and after three prior failed FTDs.

One of the strongest bear rallies ever came in the middle of the 2000-2002 bear market. After the S&P had fallen 38% from highs and experienced five failed FTDs, it rallied 25% over 108 days and to a test of the declining 40-WMA. It then went sideways for several months before eventually making another huge leg lower.

In the current bear market, the S&P 500 has experienced four failed FTDs so far in its path to reaching 25% off highs (see * below). The bear market rallies have been weaker on average in comparison to the history of bear rallies (see above). This increases our confidence that we may be due for a sharper rally should the FTD occur.

Presently, we are awaiting another potential FTD. This could occur as early as Friday, June 24, 2022. If it does occur, we would like to see some immediate price appreciation following it to give us conviction in a tradeable rally. Also, in such a scenario, we would advise adding capital to the market gradually with the understanding that at a sign of clustered distribution one should exit the trade.

Should an FTD happen, here are some areas we believe would be best positioned to continue to lead. The spaces could be used as starting points to create shopping lists for a bear rally. It is always possible that the next up move in the market will be more than a bear rally. While we are doubtful this will be the case, we always want to follow our technical signals and respect the action of the market.

We would also remain open minded about looking elsewhere in the world, as several global areas appear more intriguing than the U.S. market currently. These include Hong Kong/China (which seems to be bottoming earlier after an already protracted bear market), the U.K./Canada/Norway (energy, utility, and financials heavy), and Southeast Asia (long-term laggard markets, commodity/financial heavy exposure).

Meanwhile, we would use a potential bounce in oversold areas like the ones below, to sell into the strength, either if owned or if buying for a short-term move higher. The resistance/overhead supply in these areas is too great to be resolved in any immediate sense.

In conclusion, we remain cautious. We have no indication that the market has ultimately bottomed. Importantly, the U.S. market continues to lack breakouts, normally a sign of real market strength, with only an average of 28 over the past eight weeks versus a long-term average of over 110 per week. Also, very few stocks are presently positioned in traditional technical set ups, so the breakout figure is unlikely to spike in the near-term. However, we want to be alert to the opportunity to make money and a sharp bear market rally may offer that.

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 positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.

Source: https://www.forbes.com/sites/randywatts/2022/06/23/forbes-bear-market-rallies/