Friday, December 28, 2018
No Bears in a Bear Market
Bear markets are defined as a period of falling prices and successive rounds of stock sales as shareholders succumb to fear of deepening losses. Some characterize it as a savage cycle of negativity. This does not sound much like the typically gentle and tolerant ‘ursa.’ Nonetheless, it is the hapless bear that is tapped as mascot for this dreadful affair.
How do investors know when a bear market is coming and what should they do about it? Observations of the last bear market can provide some answers.
In number terms, a bear market is defined as a downturn of at least 20% from peak prices. The bear market is confirmed when such steep price declines are observed several broad market indices such as the S&P 500 Index and Dow Jones Industrial Index. The last bear market in the U.S. began in early October 2007 and lasted at least until March 2009.
The real savagery did not begin until October 2008. The S&P 500 Index registered a peak value of 1550 in October 2007. The high just could not be maintained in the face of incessantly dismal news from the housing and banking sectors. By mid-September 2008 the S&P 500 Index had shed 20% of its value from that lofty peak. The math alone must have had a chilling effect on shareholders.
Calculators set aside, the month of October 2008 held a new terror for investors. In Mid-September 2008, the storied investment banking firm Lehman Brothers filed for Chapter 11 bankruptcy protection, which was at that time the largest bankruptcy action in history. The company’s collapse was largely considered the consequence of Lehman’s involvement in subprime mortgages.
Lehman’s demise sent shock waves throughout the U.S. equity market. By Thanksgiving 2008 the S&P 500 Index hit 750. Yes, that was a drop of more than 50% from the peak. Digest that with your turkey and cranberries!
In retrospect it was not very palatable. What is more, the present situation in the U.S. equity market is not particularly tasty either. In September 2018 - just three months ago - the S&P 500 Index established a new high near 2,930. Yet as children were preparing plates of cookies and cups of hot cocoa for Santa and arranging carrots for his reindeer, on Christmas Eve 2018 traders trimmed the index back to a level near 2,350 for a near magical decline of 20%.
Does the earlier bear market provide clues to what investors might experience as 2019 rolls around?
When comparing the 2007-2009 bear market with today, the Fall Season to Winter Holiday timeline looks suspiciously consistent. There is something about the third quarter - as time is running out for the year - that forces investors to face facts. The winter holidays in the U.S. market in particular seem to prompt investor decisions. What has not yet transpired is that unexpected development with sufficient terror to trigger a savage sell-off.
On our horizon appears several sources of uncertainty:
· Instability in North Korea,
· Increasing warfare in Syria and ascendancy of Russian influence in eastern Europe,
· Sterile negotiations over Britain’s exits from the European Union and worries over Eurozone growth rates,
· Endless posturing by the U.S. administration over trade relations with China,
· Self-harm by the U.S. administration at our southern border with Mexico, or
· U.S. administration tampering with the historic independence of the Federal Reserve.
Whether any of these situations have the potential to deliver a true surprise and cause investors to lose hope is the penultimate question.
For those who do not have an answer there are put options.
Next to eliminating long positions today, put options might be the best course of action. A one year line chart depicting volume at price suggests that there is support for the S&P 500 Index at the 2,250 level. Not much downside protection there. The put-call ratio was 1.32 on the eve of the Christmas holiday, but has since moved closer to 1.00, suggesting the majority in the market have decided the worst is over. For some that complacency might be signal enough that the worst is yet to come. It could also be good news for affordability of a put option strategy, as reduced demand eases pressure on premiums.
There are no bears in a bear market - only anxiety and uncertainty. Wildlife experts indicate bears routinely distinguish between threatening and non-threatening situations and often share resources and security. Let us hope traders can be as insightful as the market’s chosen mascot.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
Posted by Debra Fiakas