Calling a Bear a Bear
Claiming the stock market is merely correcting looks like an error.
THE SORT OF MARKET that dare not speak its name -- bear -- is being mentioned increasingly in polite company.
It's been a few weeks since this column asserted the trend had turned lower ("A Bear Market by Any Other Name," May 21.) If anything, the tide still is moving in that direction even more strongly.
While the major stock averages aren't down the requisite 20% that conventionally defines a bear market, the odds of the current decline stopping short of that mark aren't great.
According to Bespoke Investment Group, there have been 58 "corrections" of 10% or more in the Standard & Poor's 500 since 1927. In 33 cases, the corrections stopped short of the 20% bear market threshold and the market went on to higher highs, while 25 times they grew into a full-grown grizzly.
But in the 32 instances when the market has dropped as much as this one has -- 14.4% from the April 23 peak through Monday -- the outcome has been heavily weighted to the losing side. Only seven times drops of that size stopped short of the 20% bear mark. In the 25 other times the decline extended to 20%, the average bear market decline was 35.5%.
As pointed out in that aforementioned column from last month, Dow Theory Letters' Richard Russell was unequivocal in urging his subscribers to get out of stocks. And in his latest Remarks, the dean of market technicians is even more adamant. After listing a litany of bearish technical indicators, he concludes;
"So all in all, I'm convinced through many of my studies that the top has been put in and the primary bear trend is again in force. Remember, the 14-month counter-trend advance served to hold back the bear forces, even though the bear pressure had been building up. For this reason, I'm afraid of what might occur in the weeks and months ahead. This, even though I believe a tame period is overdue."
On the latter score, Market Semiotics' Woody Dorsey proprietary sentiment readings point to some "upside tries" ahead. His Semiotics Sentiment hit an absolute 100% at the peak in late April, but has tumbled all the way to 1% in the latest reading. That could point to a bounce into June 18-23 before giving way to the Summer Bummer he's been predicting for months. For the longer term, Dorsey remains steadfastly bearish, calling from the next buying opportunity in 2012 and an ultimate "secular buy" in 2015-16.
For now, Mark Steele, BMO Capital Markets' head of quantitative and technical research, offers this unequivocal recommendation in the title of his report: "Go to Cash -- In Plain English." In a version prepared for non-technical readers, he offers this cogent summary:
"We advocate switching out of equity positions and going to cash. The European sovereign debt crisis appears to be nowhere near over. The global credit environment is worsening. Cost of capital is going up and availability is going down. There are large gaps between where the credit market prices risks and where the equity market is priced. Equity is lagging the deterioration in credit conditions. Moves in currency, equity and commodity markets are mirroring the moves in the credit market. Global growth, in a credit-constrained environment, will slow. Profits will be squeezed by the higher cost of capital."
Cyclical indicators have Albert Edwards, head of the global strategy team at Societe Generale, calling for the resumption of the structural bear market in stocks. Specifically, he points to the Economic Cycle Research Institute weekly leading indicator, which has slid sharply in recent weeks. The ECRI index, it should be noted, also caught the beginning of the 2009 recovery.
Edwards's hypothesis is that in structural bear markets, cyclical counter-trend bull markets would become more synchronized with swings in the real economy. Thus, the ECRI leading indicator has been a useful timing tool, signaling when to get into the market. Now it's doing the opposite.
"It is worth noting that despite all the anxiety this year about Greece/Chinese liquidity et al, it took a non-farm payroll disappointment to produce the second-biggest one-day decline in the Dow this year last Friday. The cycle is the key, and the leading indicators tell there is a big slowdown on the way."
Similarly, he cites Soc Gen colleague Andrew Lapthorne's work that shows equity analysts' optimism (defined as the percentage of their earnings estimates that are increased) leads the conventional leading economic indicators. Lapthorne sees a "savage slide" in optimism globally in recent weeks, including declining earnings in the Asia ex-Japan region, Edwards relates. "This rapid rate of erosion is something investors ignore at their peril," he concludes.
Finally, as this column has been pointing out ad nauseum since the beginning of the year, U.S. broad money-supply (M3) growth has turned negative, portending a renewed downturn ("Follow the Money -- Into a Double-Dip," Jan. 6.) John Williams's Shadow Government Statistics, which pieces together the M3 numbers since the Federal Reserve stopped reporting them publicly several years, finds the current 5.9% annual rate of decline to be the most precipitous since the 1930s, signaling an "intensifying business contraction."
All these relatively esoteric indicators mainly serve to confirm the message of the markets: the sharp drop in copper and other commodity prices along with the slide in Treasury yields point to a renewed economic slowdown and deflationary pressures. Stocks are catching up with that clear signal.