A Cruel Summer For Equities: Has The Bear Finally Arrived?
The stock markets have been on a one way Bullish tear for so long, it’s somewhat difficult to remember the viciousness of a Bear Market or how it might impact everything. The last real bear ended in early 2009, with the Dow Jones Industrial Average (Dow) plunging to 6500 while the Nasdaq 100 (NDX) bottomed at about 1000. At Monday’s close, the Dow stood at 24, 250, a 9 year gain 275%. The NDX closed slightly above 7,000 having had a 600% gain in the same 9 years of relentless rally.
The NDX has been led by outsized gains in a handful of stocks, also known as the “FAANG”s, or Facebook, Amazon, Apple, Netflix, and Google. Several analyses of just how dominant this handful of stocks has been to both the Nasdaq’s total return and that of the Standard & Poor’s 500 Index have been featured in website “Zero Hedge”, including: (https://www.zerohedge.com/news/2018-06-06/faang-bubble-statistics) and (https://www.zerohedge.com/news/2018-05-16/these-4-stocks-account-over-two-thirds-2018s-sp-return).
The concentration of appreciation is typical of a liquidity driven market. If there’s a lot of money sloshing around, it’s more likely to go into pools that are already large and can absorb new investment with minimum disruption. The largest 7 companies in NDX represent about half of its value (https://www.slickcharts.com/nasdaq100), which makes the index very poorly diversified despite the inclusion of 100 companies. The same phenomenon of an abundance of investment capital seeking liquid places will inevitably reverse and the need to raise liquidity will focus primarily on where liquidity exists.
As the Federal Reserve executes its intention to reverse the money printing program known as Quantitative Easing (QE), the stocks which most benefited from excess liquidity will be the stocks who will be the prime targets of the subsequent reduction in systemssic liquidity (https://www.worldfinance.com/banking/the-qe-reversal. Coincidentally, the policy of “Quantitative Easing” by the Federal Reserve BEGAN in early 2009, just as the markets were making their lows and in the last year or so, the reversal of QE has been finally undertaken with several more accompanying rises being forecast as the stated policy of the Federal Reserve.
The charts of the NDX, above and Dow, below are giving ominous patterns. The duration and extent of the prior bull markets is a major factor to consider. The daily chart of the NDQ turned more BEARISH yesterday with its break below the Ascending Wedge. It still has support at around 6500, but a break below this key level would turn the Nasdaq BEARISH and would be the confirmation of new BEAR Market. If so, the next support is at 4900, or 30% lower than yesterday’s close. A true bear market would be expected to wipe out 50% to 85% of the peak value. The BEAR MARKET following the 1995-2000 Dot Com bubble shaved the index by 85%, and if repeated would place the Nasdaq 100 back in the 1000 range.
Robert McHugh, the Publisher of a voluminous market letter and the website (https://www.technicalindicatorindex.com/Default.asp) is probably the foremost expert on the “Hindenburg Omen”, a rarely triggered or observed indicator, but described in more detail here: (http://markonomics101.com/2018/03/15/hindenburg-omen-all-over-the-financial-press/). According to McHugh’s open letter on Friday, there had been 3 Hindenburg Omens in the last 7 or so trading days. Hindenburg Omens are always present prior to great declines in stock market but are not a “sufficient condition”. Their track record is better than virtually any indicator commonly used but they only serve to increase the odds of an adverse market event in the near future. The presence of three is consistent with the new BEAR MARKET theme, but not a strong enough indicator alone to be viewed in a vacuum.
Below, are charts of the Dow. Both Daily and Weekly charts suggest that the Dow is at great risk of penetrating Its Long Term Up Trend Line, which would turn the Dow unequivocally bearish. The Dow will breach the Up Trend at about 24,000 and makes new 2018 lows at about 23,250. Should the latter occur, the DOW would not ONLY turn BEARISH, but it’s next level of support would be at about 18,000. However, since a normal bear market would shave off between 50% to 85% of the prior peak to finally hit bottom, that would put a Bear Market target low of between 13,000 and 5,000.
Adding to the ‘liquidity” theme mentioned earlier, is the recent activity in Cryptocurrencies which share the equity markets’ sensitivity to systemic liquidity. Recently, we outlined the reasons why the Cryptocurrency Sector has also entered a new phase in its 2018 Bear Market (http://markonomics101.com/2018/06/24/cryptocurrency-sector-resumes-its-historic-2018-bear-market/). In general, Cryptocurrencies and Equities have very low correlation with one exception: systemic liquidity. When the reversal of money printing occurs, the sectors who benefited the most will also suffer the most. With both stocks and cryptos in gear, risk assets of all kinds ought to join the party.
This is definitely a time for stock market investors to exercise caution. The charts are flashing red, the length and duration of the prior Bull Markets suggests that a reaction, and a sizable one. is WAY overdue. There is still a lot of complacency as evidenced to the 56% Bulls as reported by Investors Intelligence (https://www.investorsintelligence.com/x/free_chart.html?r=101l). The upside is very limited and the downside substantial. The time for caution is very warranted.