11/15 The breakdown in many of the high relative strength stocks would normally not bode well for the market. We say this because the stocks in the forefront invariably give way to selling pressure during the bulls’ final phase. The prime example is Nvidia, which had been at the top of the relative strength ratings for virtually years, has lost almost a third of its value since the end of September. Micron Technology is -36% off of its bull market highs, and Applied Materials 43%. What really caught the public’s attention has been the weakness in the Fang stocks. Facebook, which peaked in July, has dropped 34% in the interim; while Netflix, also peaking in July, has fallen 31%; Apple 17% since early October; not to mention Amazon, which has fallen 20% over the past six weeks.
But before writing “finish” to the second loa similar breakdown in late December 2015 through early 2016, which was just as severe if not more so.
Our immediate concern is the coming test of the October 25th lows. As we go to press, the key indices are only two to three percentage points away. All of the major indices, with the exception of the Dow, are now below their 50 and 200 day moving averages. On top of this, all of the 50 day lines are trending lower and in some cases the 50 day lines are in pronounced downtrends such as the Russell 2000, S&P Midcap Index, and Value Line Geometric.
All three of the aforementioned indices are exhibiting socalled death crosses. That’s when the 50 day moving average (DMA) falls below the 200 DMA. A death cross is not as foreboding as the name would imply. Having said that, we should point out that it is impossible to have a bear market without a death cross. While it certainly solidifies the prevailing trend, it often comes near the sell-off that was in effect at the time. Bespoke recently tabulated all of the death crosses that had taken place in the S&P 500 since 1930 – 24 in all. The S&P lost an average of 2.3% over the next three months following the death cross. And a year later it only gained an average of 1.72%. So historically, a death cross has accurately predicted below average returns over the next 12 months. However, as you can see by the following table, it has not been all that accurate in recent years. The last four S&P death crosses have resulted in above average gains of 8.9%, 14.1% and 17.1% over the following three, six, and one-year periods. All told, the death cross has accurately predicted lowerngest bull market in history, it should be noted that there was prices only half of the time since 1930.
The golden cross that occurs when the 50 day line penetrates the 200 day line to the upside is much more reliable and rewarding. But that’s a story for another day.
Most of the chart patterns of the widely-followed indices are clearly bearish. Since the bull market highs in late September, there have been two snapback rallies. The first only lasted three trading sessions with the S&P 500 gaining 3%. It was concluded on October 16th at 2809.
The second rally, lasting seven trading sessions, saw the S&P gaining 6.5% and ending at 2813 fractionally closing above the previous peak, but certainly not a clear-cut penetration. The rest of the indices, with the exception of the Dow, fell short with the market heading south the next day.
Since October 3rd through this past Tuesday, U.S. Crude Oil futures plunged 27% while the S&P 500 fell 7%. Many analysts feel that the collapse in the price of oil could be the prelude to a full-scale panic in the stock market. We disagree. There have been several occasions during this bull market that oil has come under intense selling pressure and in most instances it did not affect stock prices to any great degree.
As an example, the United States Oil Fund lost a quarter of its value between June 8th and August 2nd of 2016 while the benchmark S&P 500 gained close to 2% over the period. When oil fell 50% between 10/17/15 and 2/11/16, the S&P 500 fell 8%. From 6/2/14 through 1/4/16 light crude oil spiraled downward dropping from 102.92 to 33.74 losing close to 70% while over the same time frame the S&P 500 gained 6%. There are several other examples in which the price of oil fell substantially while the S&P 500 held its own or gave ground grudgingly. Cliff Droke in his most recent letter laid it out quite well:
“Clearly, there is concern among investors that falling oil prices could exert a negative impact on the stock market. But how much of a threat do lower oil prices really pose to stocks? The last time there was an oil-related sell-off in U.S. equities was in late 2015. It contributed to a bear market in the Russell 2000 Small Cap Index and a correction in several major indices. Are we on the verge of another extended period of weakness for stock prices?
The reason why we won’t likely see a repeat of this scenario is found in the dollar index, which we discussed above. In late 2015, the dollar index began to weaken and even crude oil price was plunging to multi-year lows. The dollar index also failed to overcome its previous high from earlier that year while the oil crash was underway. This meant that there was legitimate concern among investors that the U.S. economy was vulnerable to a recession due to the oil market bust. This time
around, however, there is no such vulnerability and the dollar is reflecting a strong economic condition.”
In conclusion, there are many telltale signs that a bear market is about to take hold. Our short term models have already turned negative. That is why we have elected to cut back to an approximate 50% invested position.
In our opinion, it is still too early to throw in the towel. We base this on the fact that our long term models are still positive. And as long as they remain so, we will continue to give the bull market the benefit of the doubt.
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