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Why The Bear Market is Back, With One Silver Lining

Simon Maierhofer

For a bear market to start a bull market has to end. What constitutes a bull market? Is the roaring bear about to take over the weakening Bull?

A 20% move is commonly used to delineate a change of direction (a 20% drop is a new bear market and vice versa).

The S&P (SNP:^GSPC - News) has rallied as much as 30% since the October 2011 low and more than 113% since the March 2009 low. So when did the new bull market start? In 2009 or 2011? How long will it last?

Did the Bull Market Start in 2011?

A bull market can only start after a bear market. From May to October the S&P dropped 17.41% based on its closing high/low and 21.30% based on intraday high/low. Does this constitute a bear market?

Yes it does, at least according to Wall Street and the financial media. Below are headlines published on October 4, 2011 when the S&P traded below 1,100:

"S&P enters bear market territory" - Reuters

"S&P falls to the bears" - TheStreet

"U.S. investors can't escape Europe's debt crisis" - CNBC

Rather than using the static 20% rule, the ETF Profit Strategy Newsletter relies on a combination of technical, sentiment, seasonal indicators and plain common sense. Based on those indictors the October 2, ETF Profit Strategy update was expecting a major low and stated:

"October should spur a powerful counter trend rally. Buy after the S&P registers a new low (around or below 1,088) and comes back up above resistance at 1,088."

The 20% change rule is an after-the-fact indicator and as effective as looking in the rearview mirror while driving. An ounce of prevention is worth more than a pound of cure, which is why the April 2, 2011 ETF Profit Strategy update issued a forecast that saved investors a ton of pain:

"A major market top is forming. 1,369 - 1,382 range is a strong candidate for a reversal." A pro-active approach not only protected investors against a 20% summer drop, it also produced profits on the short side and prevented a seesaw sell signal (like the media's) in October 2011.

Based on the lack of sustained bear market action, it seems unlikely that the rally from the October 2011 lows is a new bull market (with its start in October 2011). If it is a new bull market, it may be as short as the previous bear market.

Did the Bull Market Start in 2012

No doubt the 50%+ decline in the Dow (DJI:^DJI - News), Nasdaq (Nasdaq:^IXIC - News) and S&P from 2007 - 2009 qualifies as a bear market. Any subsequent rally from the 2009 lows could therefore be considered a new bull market (although it's not my preferred view as discussed in a moment).

There are two points that make the "bull market started in 2009" idea quite unattractive.

1) Historically, bull markets have averaged about 39 months in length. As of June 2012, the new bull market would be 39 months old and ready to end.

2) Since 1940, no bull market has ever experienced more than one decline of 10% or more (based on closing prices). Since the 2009 bottom however, the S&P declined 17% in 2010 and 21% in 2011.

Either something major has changed or the rally from the 2009 low is not a bull market. If it isn't a bull market, what is it?

Topping Process Details

The bottom line is this: If the bull market started in 2009, it is very aged and running on borrowed time. If the bull market isn't a bull market, it is simply a retracement of the previous 2007 - 2009 decline that will lead to the next leg down.

Either way, the longer-term implications are all but bullish. >> click here for larger chart


There's one thing all market tops have in common: They are rarely sudden events, but tend to play out over a series of months. Like marathon runners, not all indexes hit their respective high water marks (finish line) at the same time, nevertheless there is no doubt that the race (bull market) will end.

The Russell 2000 (Chicago Options: ^RUT) for example reached its all-time high in April 2011 and its 2012 high back in March. The Dow Jones recorded its 2012 high on May 1, but it was only a 52-month high.

The Nasdaq rushed to its 2012 high on March 27. This wasn't an all-time high but the highest reading since November 2000.

Obvious but Hidden Erosion

Certain indexes hold up better than individual stocks. The Dow for example, topped out in January 2000 and October 2007. On the day the Dow peaked in January 2000, 55% of NYSE-listed stocks were already down more than 20%. The day the Dow peaked in October 2007, 27% of NYSE-listed stocks were already down more than 20%.

On May 1, 2012, when the Dow peaked at 13,339, 30% of NYSE-listed stocks were already down more than 20%. In other words, the market may erode unrecognized in plain sight.

The chart above outlines prior market peaks (dotted red boxes). The topping process is like knocking over a coke machine. You can't do it in one push, you have to rock it back and forth a few times before it tips. But once it tips, the damage is sudden and obvious.

Silver Lining

Things (in particular sentiment) are so bad they are almost good or in more proper Wall Street jargon; excessive pessimism tends to breed rallies. This is the case about 8 out of 10 times. The 2 failures however are usually free fall type declines.

How do you separate a free fall decline from a tradable bottom? You look at crucial support. If the S&P stays above crucial support it is likely to rally, if it doesn't watch out.

The ETF Profit Strategy Newsletter identifies the must hold support and the target level for this decline.

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