SPX Bear Technicals
Adam Hamilton
Archives
Aug 22, 2008
Back in mid-July, as Fannie
Mae and Freddie Mac teetered on the edge of collapse, the flagship
S&P 500 (SPX) stock index plunged to 1215 on a closing basis.
Fears ran high as the markets waited for the next shoe to drop
in the ailing financial companies. The near-term outlook for
US stocks seemed pretty bleak.
But how fast popular sentiment
changes! In less than a month after these depths were witnessed,
the SPX had rallied 7.4%. By mid-August the troubles of the previous
month had been all but forgotten. Calls for a new bull market
abounded, with the great majority of analysts expecting clean
sailing ahead. And those that do remember mid-July now largely
seem to think it was GSE-specific and not a broader issue.
With such a sweeping shift
in popular sentiment, it is easy for the casual observer to forget
just how ugly this past year has been for the US stock markets.
The SPX is mired in the first cyclical bear it has witnessed
since the early 2000s. These dangerous beasts tend to cut elite
blue-chip stock prices in half before they return to their caves!
But at worst in mid-July, this SPX bear was only down 22.4% since
it awoke in early October.
While 22% probably feels plenty
extreme to those on Wall Street, it still falls far short of
the 50% this bear could ultimately maul away based on historical
precedent. That would equate to climax lows near 785 on the
SPX and 7100 on the Dow 30, vastly lower than the levels seen
during the mid-July selloff!
With such massive additional
losses quite probable, investors really need to research whether
or not this young bear still prowls. Based on the answer to this
critical question, the most prudent trading strategy for the
coming year will vary radically. Trades that will thrive in the
new bull Wall Street is boldly heralding will be crushed in an
ongoing bear market.
So is the SPX bear still alive
and well despite the rally off of mid-July's lows? The SPX technicals
offer plenty of clues. Since a bear market is simply an ongoing
decline in general price levels, its progress is readily apparent
on a longer-term price chart. And bears are born in extreme greed
and die in extreme fear, so analyzing prevailing sentiment in
the US stock markets will offer even more clues to this bear's
longevity.
It's best to start with technicals,
or the SPX price action. In this CNBC era of a relentless moment-by-moment
focus on the stock markets, it is sadly getting increasingly
rare to see a chart extending back more than a month. Yet such
a myopic short-term focus effectively blinds investors to profound
market truths that eagerly leap out of longer-term charts. Proper
technical perspective is exceedingly important.
As a student of the markets,
to me even a one-year chart is short-term. But even at this scale,
the SPX rally of the past month doesn't look all that impressive.
What looks like a surging bull market considered in isolation
is truly a rather inconsequential bounce when viewed from a longer-term
perspective. With the SPX trading at such low levels, the burden
of proof remains squarely on the bulls.
A bear is defined as a prolonged
period of stock prices declining on balance. This means lower
highs and lower lows, interim extremes on both sides gradually
trending lower. We've certainly seen this phenomenon unfolding
in the SPX. This index's 200-day moving average also rolled over
in January. A 200dma deftly distills out all the day-to-day noise
to point in the primary trend's direction like an arrow, and
the SPX's is heading lower.
Wall Street, which is loath
to ever declare a bear since it is so bad for business, waits
for the last possible moment to make the proclamation. Thus its
definition of a bear is a 20%+ decline from the latest interim
high. This metric was officially hit on a closing basis on July
9th, so even Wall Street has no excuse to dance around disclosing
this bear market. And since this 20% decline level is around
1250 on the SPX, it has already spent the better part of two
weeks in official bear territory.
Over the past year this bear
has unfolded in textbook fashion too. It emerged out of an all-time
secular high in early October. Until the SPX's 200dma decisively
failed, in early January, it was unclear whether the early selling
was a bull-market correction or bear-market downleg. But the
farther the SPX fell under its 200dma, which is major support
in an ongoing bull, the more powerful the bearish case looked.
I wrote about the increasing odds for a new cyclical bear in January
when Wall Street scoffed at such a heretical notion.
By March, the selling was intensifying
and the SPX was floundering farther and farther under its 200dma.
The fear driving this selloff peaked on March 10th and the SPX
bounced. It had fallen 18.6% in this initial bear downleg, nearly
enough to achieve official bear-dom. Interestingly the financial
stocks of the SPX, which are tracked in the XLF Financial Select
Sector SPDR, fell 34.7% over roughly this same span of time.
Every bear has a leadership
sector, such as the tech stocks during the early-2000s bear.
This time around it is the financial stocks. They grew fat and
complacent during Alan Greenspan's excessively-low interest-rate
environment, feasting on easy money and leveraging themselves
to the hilt. Today they are paying for their past excesses. And
leadership sectors don't change once a bear commences, they keep
leading and amplifying general-market losses all the way to the
bear's final climax.
So in addition to the blue
percentages in this chart measuring the SPX's big swings within
this bear, I also noted the XLF's in red. While these don't always
coincide exactly to the day (the XLF doesn't necessarily bottom
or top the same day the SPX does), they are close (within a week).
Thus the XLF swings noted are representative of the financial
sector's performance during these big swings in the headline
SPX.
After its early-March lows,
the SPX entered a bear rally. Bears are exceedingly crafty and
subtle beasts. They do most of their work when fear is relatively
low and few are worried about them. But once prices fall far
enough that the bear takes center stage and fear gets excessive,
the bear wisely retreats for a spell so it doesn't scare its
quarry away. The result is strong bear rallies that fool naïve
bulls into thinking the bear is gone for good. Bear rallies are
the biggest and sharpest surges higher that stock markets ever experience.
This particular bear rally
ended in May, with a 12.0% gain in the SPX and an 18.2% gain
in the XLF. And provocatively, this rally failed right at the
SPX's 200dma. Just as 200dmas are major support in ongoing bull
markets, they become major overhead resistance in ongoing bear
markets. This particular point as a technical failure in May
was very telling. It was a clear technical warning we were in
primary bear mode.
The next downleg
erupted out of the complacency of the May interim high. It was
fast and furious, a 14.8% selloff in the SPX in less than two
months! And the financial stocks once again led the broader markets
lower and amplified their losses. The XLF fell another 38.0%
over this short span, brutal by any measure. And by early July
the SPX officially entered bear territory with a 20%+ loss on
a closing basis since October.
Despite achieving Wall Street's
own bear metric, Wall Street still refused to call a bear a bear.
You have to remember that the financial stocks are Wall Street.
They employ the analysts we see on CNBC and pay the salaries
of the great majority of the professionals involved in the markets.
So for Wall Street, having the financials lead this bear is the
worst possible scenario. Even if the financials fell to zero
Wall Street would still hem and haw and refuse to acknowledge
the reality and danger of this bear.
Since mid-July, the SPX has
rallied 7.4% while the financials as measured by the XLF have
soared 31.3%. Since the bear leadership sector is the most heavily
sold in the downlegs, it also bounces higher and faster in the
bear rallies. Radically oversold stocks can rocket up fast as
sentiment changes, as the XLF is really illustrating today. Thanks
to this big financials rally, Wall Street has boldly declared
a new bull market.
From early October to mid-July,
the SPX ultimately fell 22.4% on a closing basis. This alone
should scare the heck out of investors, as these are the biggest
and best stocks traded on the US exchanges. Over roughly this
same span of time, the XLF plummeted 52.2%! This is extreme,
but realize bear leadership sectors do much worse than the general
markets. In the early-2000s bear, the leadership technology sector
as represented by the NASDAQ 100 ultimately lost a staggering
82.9% of its value!
Historical precedent be damned,
Wall Street is declaring this bear dead. After all, with the
very Wall Street financial companies' stock prices more than
cut in half, the selling must be over, right? Not at all. It
is not absolute price levels, or percentage losses, that drive
the end of a bear. It is sentiment. Bears persist until popular
fear grows so great that everyone remotely interesting in selling
has already sold out in disgust.
Prevailing fear is ethereal
and impossible to quantify. But thankfully outstanding proxies
exist to reflect fear based on price action. Among the best of
these tools are the implied volatility indexes. By distilling
down all options bets made on a particular index, like the SPX,
they offer great insights into prevailing sentiment among traders.
While the VIX is the SPX's implied volatility index, I prefer
the old-school VXO which actually measures implied volatility
for the S&P 100 (effectively the top 20% of the SPX's stocks).
The VXO is battle-proven, it
existed during the early-2000s bear so we know what to expect
from it during periods of extreme fear. Meanwhile today's VIX
was born in September 2003 and uses a new calculation methodology,
so no one yet knows exactly how it will react during the extreme
fear episodes of a bear. For a deeper explanation of the VIX
versus the VXO, check out our current newsletter and an essay
I wrote last month.
Since the VXO effectively measures
fear, and since bear markets end at definite VXO levels, it gives
us a high-probability understanding of whether or not the July
lows likely marked the end of this bear as Wall Street so desperately
hopes. The red VXO is rendered under the blue SPX here. And the
story this leading implied volatility index tells about general
fear these days is very provocative to say the least.
Back in the earlier months
of this bear between October and March, fear rose on balance
as it should. The VXO's meanderings as fear flowed and ebbed
over this period of time actually defined the nice uptrend rendered
above. This is the way bear markets are supposed to work. The
longer general stock prices fall on balance, the more popular
fear grows. It starts unnoticed in the background but gradually
takes center stage.
At major SPX turning points,
the VXO extremes are noted as two red numbers. The top one is
the level the VXO hit intraday while the bottom is the VXO close.
For example, in January when fear grew too great to sustain the
first big selloff of this bear, the VXO surged to 38.9 intraday
while its highest close was 33.2. At the March bounce in the
SPX, the VXO managed 37.2 intraday at worst while hitting a 34.3
close.
Interestingly, even back then
it was apparent that there wasn't enough fear to end this bear
market. If you study the VXO during the last cyclical
bear of the early 2000s, it becomes evident that actual bears
aren't likely to end until the VXO hits or exceeds 50 on a closing
basis. And even early on in bears, individual downlegs aren't
likely to yield to bear rallies until the VXO hits the mid-30s
on a closing basis and the high 30s on an intraday basis. The
first big downleg in that early-2000s bear didn't end until the
VXO hit the lower 40s intraday and closed over 39.
Thus even back in mid-March,
it was already clear that fear definitely wasn't high enough
to end this bear. And it was even on the low side to merely end
that downleg, although a rather anemic SPX bear rally did ignite
out of the March lows. But after this, fear soon mysteriously
disappeared. The VXO started plunging and eventually fell off
a cliff. All the trepidation felt by traders in mid-March was
soon forgotten.
Fear bled off a lot faster
than it should have. By mid-April, the VXO had broken below its
support line and fell into the lower 20s. By late April it was
down in the high teens, which is extremely low for even the youngest
bear. In mid-May the VXO plummeted to 9.4 intraday and 12.9 closing,
which was significantly lower than its levels in early October
at the start of this bear! While I suspect that day was some
kind of mathematical anomaly, the high teens of the rest of May
were still nearly as low as early October's levels.
With fear so unbelievably low
in May, it is pretty obvious that most traders weren't taking
this bear seriously. The Wall Street propaganda machine relentlessly
beats the endless-bull drum, so investors and speculators consuming
only mainstream financial news start to believe the hype. Throughout
this whole bear, with the short-lived exceptions of the V-bounce
points, Wall Street has ignored it and denied it even exists!
Prevailing fear levels fell
so incredibly low in May that even during June's brutally steep
SPX selloff the VXO lingered in the lower 20s. While fear in
the financial sector ran high, general-market fear didn't. By
the mid-July SPX lows the VXO finally spiked near 30, but these
were still very low fear levels relative to what typically ends
a bear-market downleg. Since then the SPX has rallied modestly
while the VXO quickly fell back to the low 20s. Amazingly traders
have been so complacent that the VXO is in a downtrend despite
lower prevailing SPX levels!
And the relative positions
of the SPX and VXO in the last couple weeks are very telling.
The SPX bounced out of mid-July, but its rally appears to be
failing at its 50dma. The 50dma is the most common point within
ongoing bear downlegs where minor-bounce rallies peter out. This
is in contrast to major bear-market rallies between downlegs,
which tend to run all the way up to the 200dma before failing.
In addition, the VXO is now
very low, equivalent to late-October levels, which shows little
prevailing fear. Despite all the bearish technicals, the great
majority of traders still aren't even close to taking this bear
seriously! Not only has Wall Street misled them, but this bear
is exceedingly crafty in not letting fear get out of hand. The
fact that fear remains scarce and the mid-July fear levels at
the latest SPX bounce were far too low to end this downleg strongly
suggests that more selling is yet to come.
And this selling will drive
new lower lows in the SPX, probably in the next couple months.
Eventually general stocks will fall far enough to spark enough
fear to generate a selling climax of sufficient intensity to
end this downleg, but probably not this bear. Cyclical bears
tend to run for a couple years or so before giving up their ghosts.
We are just one year into our current one.
In addition to the lack of
fear, other factors argue for lower stock prices in the coming
months too. I've discussed them this year in our subscription
newsletters. One example is the upcoming US elections. If the
leading candidate wins, he wants to double long-term capital-gains
taxes! As the likelihood of an Obama victory grows, investors
will sell stocks in advance to lock in today's much lower LTCG
taxes before the election and inauguration. Political taxation
fears could intensify selling.
Thankfully there are tons of
awesome new bear-market trading vehicles that didn't even exist
during the last cyclical bear of the early 2000s. This brave
new world full of ETFs and ETNs gives stock traders all kinds
of innovative ways to bet on falling stock markets. In recent
months I have been discussing some of the best, as well as trading
them, in our subscription newsletters. Join
us today to learn more about practical bear-market trading
and to mirror our upcoming bear-oriented trades!
The bottom line is the price
action in the US stock markets continues to look very bearish
despite the endless stream of Wall Street assurances to the contrary.
Not only are we seeing lower lows and lower highs, the technical
definition of a bear, but popular fear remains quite low. Bear
downlegs in history didn't end until general fear reached high
levels as measured by the VXO. We aren't even close yet.
So stock traders ought to be
very wary heading into the busy autumn trading season this year.
The prevailing market trend remains down, and all kinds of nasty
surprises have yet to emerge out of the financial stocks. They
made countless bad bets, with extreme leverage, that we don't
even know about yet. So there should be plenty of upcoming bad
news in the financials to continue leading the SPX lower.
Adam Hamilton, CPA
August 22, 2008
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!
Copyright©2000-2025 Zeal Research All Rights Reserved.
321gold Ltd

|