Is This Bear Market Returning To Hibernation Or Here To Stay?

As mentioned in my last article, the current bear market is likely to be a significant multi-year buying opportunity in U.S. stocks. Watch for clues that the bear market is ending and that stocks are ready to enter a new upcycle, which we can begin to understand by looking back at past market bottoms.

Using the DJIA as proxy for the overall equity market, we can examine the characteristics of bear markets since 1900. The data shows that the median bear lasts essentially a year and a half (77 weeks). The shortest bear market over the last 120 years was in 1987, lasting only eight weeks. The current bear started February 12 and is now entering its seventh week.

The Dow’s March 23 low implies a drawdown of -38.4%, brutal in terms of velocity but still above the typical drawdown of -42%. Only two bear markets have similar velocity, 1929 and 1987. If the March 23 low proves to be the market’s bottom, it would be the shortest bear on record and less severe than average. Given the level of U.S. and global economic damage, especially to small businesses, we think it’s unlikely this bear will be so short.

Major bear markets often have three down legs. The current bear has had, at best, two down legs. While the market need not make a new low to complete the bear cycle, a close retest of lows is often common before all sellers are shaken out and the market is ready for a new uptrend. Bear market rallies can be much sharper than those in bull markets, where gains are usually more gradual.

The market’s 24% up leg last week is an outlier in terms of strength and draws another comparison with the bears of 1987 and 1929, which both had 24%+ moves higher from their first major lows but diverged from there. In 1987, the market held onto lows over the next few months, even with a retest two months later. In 1929, the market fell another 30%+ to its true low, then rallied significantly over the next nine months.

Unless the market has already turned and we are in a new bull, which we find unlikely given the short duration, the subsequent down leg averages -18% (see table below). If we have actually bottomed, the pullback from this up leg could be much less severe. Nine bull markets began with an up leg of 24%+ and had an average pullback thereafter of just 9%.

A proprietary indicator we examine at William O’Neil + Company is the number of breakouts in the U.S. market; a breakout is defined as a stock moving through a previous left-side high price pivot after a consolidation of at least five weeks. Breakouts are usually indicative of a powerful price move upward. Very few U.S. stocks are currently set up technically for strong upward moves (see chart below), reinforcing our view that this bear will be around a while longer. Most stocks are forming the left side or middle of a chart pattern, while very few are near pivots and almost none are breaking out.

Our stock-picking discipline, the O’Neil Methodology, takes its direction from the market. So at this time, we continue to wait for a strong follow-through day, where the market rises 1.7% or more on higher volume than the previous day. Once this occurs, we slowly commit capital to leadership stocks with high relative strength that are emerging from clear bases, something we are currently not seeing. While we believe the current environment will be an excellent opportunity to buy stocks at attractive prices, it’s important to wait for the proper technical signals before getting back into the market.

Industry groups showing early signs of leadership that could continue to lead when the market improves include biotech, cloud software, teleconferencing, internet-retail, discount/staples-retail, gaming, semis (datacenter), restaurant-delivery, and gold mining.

DISCLOSURE:

No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. William O’Neil + Company, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.

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