A bear market is simply a prolonged period of falling prices. These dreaded beasts come in two distinct breeds, secular and cyclical. Secular means long periods of time, on the order of a decade or more in financial market terms. The U.S. stock markets actually have been continuously mired in a secular bear for over a decade now. So, any new stock bear can't be secular, as we're still languishing in an old one.
At the other end of this duration spectrum are the shorter-term cyclical moves. In the financial markets, cyclical generally implies a couple/few years or so. Cyclical bulls and bears occur within their secular cousins. Secular bulls and bears, driven by Long Valuation Waves, tend to persist for 17 years each. Inside these great 17-year trends, several-year cyclical bulls and bears perpetually alternate.
Any new stock bear Friday has to be cyclical. The U.S. stock markets (as measured by the flagship S&P 500 stock index (SPX) soared 102% higher between March 2009 and April 2011 in a powerful cyclical bull. So, a cyclical bear is certainly due next when the past couple years' bull inevitably gives up its ghost at some point. Is that time now? Maybe, but we don't have a high-probability new bear setup yet.
All this secular-cyclical, bull-bear stuff is much easier to understand once you see it visually. This first chart superimposes Friday's SPX secular bear since 2000 over the last secular bear that ran from 1966–1982. Note that contrary to popular assumptions on bears, their secular variants don't see prices fall straight down. Instead, a secular bear is a long consolidationa demoralizing 17-year sideways grind.
These giant secular-bear trading ranges are readily evident in this chart. Ever since the last secular bull ended in early 2000, the SPX has traded in a massive sideways range running from roughly 750 on the low side to 1,500 on the high side. Friday's secular bear started near 1,500 in March 2000, and this level isn't likely to be significantly exceeded until this secular bear fully runs its course by 2016 or so.
However, within the bounds of this secular trading range, powerful cyclical bears and cyclical bulls meander. The cyclical bears tend to cut the headline S&P 500 in half, while the subsequent cyclical bulls tend to double it. These big swings are very tradable, but their net result is a wash. Even at the peaks of these mighty cyclical bulls, the SPX doesn't achieve levels much better from where its secular bear was originally born.
The latest cyclical bull running from March 2009 to April 2011 definitely achieved this doubling, rallying 101.6%. This is nearly identical to the previous cyclical bull's 101.5% gain between October 2002 and October 2007. So with this latest doubling right in line with classical mid-secular-bear cyclical-bull expectations, isn't a new cyclical bear likely? Unfortunately, the answer is not as clear-cut as usual.
Back in autumn 2008, the U.S. stock markets plummeted in the first true stock panic in 101 years. These ultra-rare events are driven by a mind-blowing explosion of popular fear. That fear, as measured by the definitive VXO fear gauge, climaxed in November 2008 when the SPX closed at 752. This was right at the lower support of this secular bear's trading range, where Friday's cyclical bull ought to have been born.
But, unfortunately, in early 2009, the United States of America suffered a change in management thanks to the stock panic's horrendous impact on sentiment during the November 2008 elections. In early 2009, the incoming Democrats terrified the stock markets with their brazen claims that the already-crushing taxes on American investors and businessmen were too low. They also threatened endless new job-destroying regulations, primarily socialized medicine, that would choke off the fragile post-panic recovery.
This Democrat despair peaked in early March 2009, driving a much-lower secondary panic low of 677 on the SPX. Not only are such secondary lows unheard of in the history of panics, but the fear reads of these two bottoms confirm this was a curious anomaly. When the SPX hit its original and true panic bottom of 752 in November 2008, the VXO fear gauge closed at an epic 87.2! But in March 2009, when the SPX slumped to 677 in despair, the VXO merely closed at 51.5. This was 41% less fear!
Fear, and hence, the proper stock panic climaxed in November despite the lower secondary March low! Even though this secondary low was not righteous, a total anomaly, the subsequent cyclical stock bull is still measured from it. March's 677 was 10.1% lower than November's 752. If we instead consider this bull as launching from its true panic low, it was up only 81.2% by its latest interim high in late April 2011.
Traders can get in trouble by failing to relegate anomalies to their proper context. Technical analysis is often more accurate for gaming future price action if extra-trend anomalies are simply disregarded. While this thread is too peripheral to hang the whole new-cyclical-bear question on, it is provocative. Yes, the latest SPX cyclical bull achieved its expected doublingbut that was from a short-lived anomalous base.
Way more important is where the SPX was Friday within its giant secular trading range. Remember that since 2000, this flagship index's secular resistance has run around 1500. In March 2000, the SPX hit 1527 on close before the first cyclical bear of this secular bear emerged from hibernation. In October 2007, before the second cyclical bear was born, the SPX briefly hit 1565 on close. Cyclical bulls fail near 1500.
Yet in April 2011 when our latest cyclical bull hit its best levels, the SPX was only at 1364. This was still 9.1% under its secular resistance, which is pretty low to kill a major cyclical bull. Stated the other wayeven from its latest April peak, the SPX would have had to rally another 10.0% to hit its 1,500 resistance, which would almost certainly signal the beginning of a new cyclical bear.
It's certainly true that not every cyclical bear has to drag the SPX down to support, nor does every cyclical bull have to carry it up to resistance. The red 1970s secular-bear line above really drives home this point. Secular trading ranges, like all trading ranges, are probability bands. The closer to support a price travels, the greater the odds a major rally is imminent. The closer to resistance, the more likely a major correction is nearing.
Having the SPX relatively high in its secular trading range in late April makes a new bear market far more likely than it was earlier in this bull. There were new bear fears in the summers of 2009 and 2010, which I argued were irrational then partially based on this analysis. And while the odds of a new bear are much higher now than in the last couple summers, the SPX still has lots of room to run. But to hit its secular resistance, that would herald a high-probability cyclical bear.
So, the cyclical bull-bear cycles are not overwhelmingly predicting a new cyclical bear Friday. While Friday's cyclical bull, indeed, hit its target doubling, it was from an anomalous secondary low well under secular support. And this latest cyclical bull hasn't yet pushed the SPX anywhere near its secular trading range's resistance ~1,500. A new cyclical bear Friday certainly isn't a high-odds bet yet.
This second chart zooms in to just the secular bear trading ranges and looks at another aspect of mid-secular-bear cyclical bulls. Their durations. Our current cyclical bull is only 26 months old, which is maturing but still on the young side for mid-secular-bear cyclical bulls. This also means we aren't yet to the point where there's a high probability a new stock bear is being born.
In the entire modern history of secular bears, there have been five cyclical bulls before Friday's. This includes an earlier one in Friday's secular bear, and four back in the 1970s secular bear. Their average duration was just under 35 months. Friday's sixth cyclical bull is only 26 months old since March 2009, or 29 months old if you want to measure from the November '08 true panic low.
While it is maturing, it remains far from even hitting an average duration yet. This, too, really reduces the likelihood that a new cyclical bear is being born Fridayespecially after a once-in-a-century stock panic. Following the last cyclical bear's epic fear at its climax during the panic, a bigger and longer cyclical bull than normal is highly likely. Market extremes, both in technical and sentimental terms, are gradually erased by outsized swings to the opposite extreme.
So, it is hard to imagine Friday's cyclical bull ending before it has even reached an average lifespan around 35 months. Odds are it will persist longer, at least if it isn't to the top of its secular trading range yet. There is a good chance the SPX will start rallying again after the current correction, in autumn at the latest. It will probably power higher through spring 2012, before the ridiculously negative election rhetoric hammers sentiment once again.
As cyclical bulls mature, their ascent rates tend to moderate. Bulls' best gains happen right out of the deeply oversold fear-laden lows left by climaxing cyclical bears. Their first years are their best, as capital floods back into stocks. But the more capital that returns, the less is left on the sidelines so the buying pressure slows in relative terms. So if our current cyclical bull indeed yields a third year, we can't expect anything more than modest gains (from April's high) into next spring.
This discussion may seem ambiguous, but calling transitions from cyclical bulls to cyclical bears is always fraught with uncertainty. Unlike fear-laden cyclical-bear climaxes, which are sharp and crystal clear, cyclical-bull toppings are usually slow and plodding. The greed that drives cyclical-bull peaks is a much less-urgent emotion than fear, and slower to build and grow excessive. Was the SPX's latest interim high greedy and complacent enough to kill this latest bull? Only time will tell.
Cyclical-bull-to-bear transitions are only readily apparent in hindsight. As mere mortals, we can't know the market future before it happens. All we can do is game probabilities. And while the odds of a new cyclical bear are certainly growing, they remain far from approaching the very-high levels necessary to actively bet on a new stock bear thesis. We won't know for sure a new cyclical bear is upon us until the SPX falls 20%, which officially marks bear territory.
A 20% decline in the SPX from its late-April high would take it to 1091. That's still a long way down from here! But cyclical bulls can see big corrections that approach cyclical-bear magnitude but never quite hit that 20%. I labeled some big mid-bull corrections in this chart that occurred in the latter halves of the last couple secular bears. They averaged 15.2% declines in a little over eight weeks.
The best modern example occurred last summer, when the SPX fell 16.0% over 10 weeks culminating in early July. That was a big selloff, but it certainly didn't mark the birth of a new cyclical bear. Corrections are healthy and necessary within ongoing bull markets. They rebalance sentiment by quickly injecting fear to offset greed and complacency before they get too excessive. Without corrections, bulls would burn themselves out prematurely.
Back in mid-April soon before Friday's selloff started, for a variety of reasons I predicted an imminent correction in the SPX. Complacency and greed were again approaching unsustainable extremes and needed to be rebalanced away. Corrections are mid-bull selloffs running between 10% and 20%, with pullbacks being under 10% and bear markets over 20%. As expected, that correction is indeed now coming to pass and won't end until fear gets high enough.
The ironic thing about healthy mid-bull corrections is traders always mistake them for new bear markets! You may recall this happened last summer during this cyclical bull's only correction. The popular new-bear belief was so prevalent by mid-July 2010 that I wrote a whole essay debunking it. This contrary opinion was very unpopular at the time, as traders extrapolated that selloff continuing indefinitely.
But those who believed last summer's false bear theories missed a super-profitable cyclical-bull year since. The lower Friday's selloff drives the SPX, the more prominent new-stock-bear theories will become yet again this summer. Before the SPX decisively bottoms, odds are popular consensus will be talking about nothing but bad news and the budding "new bear market." But such fears and anxiety are totally normal in healthy bull-market corrections, and necessary to rebalance sentiment.
It's critical for investors and speculators alike to realize that price action drives newsnot the other way around as most assume. After the stock markets have been rallying for a long time in a strong upleg, there's nothing but great news and rosy optimism just as the markets are topping. After a major correction, all you see is bad news and pessimistic rationalizations about why we're plunging into a new bear. News flow is super bullish at major interim highs and super bearish at major interim lows!
So, bear talk is actually a contrarian indicator. The more traders are talking about a new stock bear, the greater is popular fear. And the more extreme fear gets, the higher the odds that a major bottom has arrived. Just last week, I heard the first new bear comments I've seen on CNBC since last summer, and I expect this thread to grow way more popular before this correction runs its course. But bear talk doesn't make a bear.
Friday's cyclical bull, while maturing, remained far from its secular resistance at its latest interim high in late April. While it did experience a doubling, that was from an anomalous post-panic low that wasn't righteous. And this bull remains well below the average mid-secular-bear cyclical-bull duration. And if there was ever a time to see a longer-than-average cyclical bull, it is after a once-in-a-century stock panic. So, despite the increasing bearish talk, we don't have a high-probability setup for a new cyclical bear yet.
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The bottom line is the odds are not high today that a new stock bear is upon us. The past couple years' cyclical bull remains well below the average duration of mid-secular-bear cyclical bulls. And the SPX's latest interim highs also were well below their secular-bear resistance. Following a once-in-a-century stock panic's epic fear, the subsequent cyclical bull should be bigger and longer than normal.
So, we're probably due for another year or so out of this cyclical bull before the next bear awakens, albeit with moderating gains. Nevertheless, as always during healthy mid-bull corrections the new-bear talk will grow in popularity. This is a natural consequence of the increasing fear and anxiety that corrections spark, and a great contrarian indicator. Corrections bottom just when everyone expects a new bear.
Adam Hamilton, CPA
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