Bearish Market Indicators

Don Dony Much has been written about a pending correction in the stock market recently. After all, the S&P 500 has been advancing for over eight years and is up a staggering 190 per cent since 2009. The TSX has also done well with a respectable 80 per cent over the same timeframe. Surely, another bear market is due at any time.

This “potential” downturn has fostered many website and financial articles to focus on the fears of investors rather than the reality.

The purpose of this article is to remind investors of some basic truths.

Fear and greed are more powerful than long-term resolve. Investors can be their own worst enemies, particularly when emotions take hold. Gains make us exuberant; they enhance well-being and promote optimism. Fear increases the sense of risk.

Markets are strongest when they are broad and weakest when they narrow. Think of it as strength in numbers. Broad momentum is hard to stop. Currently the percentage of stocks that are rising on the NYSE, S&P 500 and the TSX is around 70 per cent.

This time is different. Market pundits often state “This time is different. It is a new economy”. But in human nature, nothing is new.

When all the experts and forecasts agree, something else is going to happen. As an S&P investment strategist once put it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

The market is far from a random vehicle, but rather a vast collection of ideas and perspectives. And shifts to a more defensive stance (a prolonged downturn) are measured in months not days. Market rollovers are a process of shifts in viewpoint from optimism to concern to fear. This change is first telegraphed in the price – more sellers than buyers. Several months after the peak, the fundamentals start to align with the price action. A perfect example happened in early 2008. The market began to sell off while the market fundamentals were quite buoyant. It was not until mid-2008 that the fundamentals began to show signs of stress. But by that time, the S&P 500 and the TSX had fallen about 28 per cent.

Several elements within the markets do provide a “heads-up” when there is concern and could offer investors a possible early warning to shifts in perspective.

Gold, 10-year U.S. bonds and the Japanese Yen are traditional vehicles that investors turn to when they become concerned. However, gold has lost much of its safe-haven allure over the last decade and has been replaced by the U.S. dollar. Case in point, at the height of the melt down in 2008, the U.S. Dollar rose 20 per cent and spot gold declined almost 30 per cent.

Another key indicator that highlights the change in investors’ market perspective is a shift from the consumer discretionary sector (those items that people want but don’t need) to the safer consumer staples sector (those items that people need but don’t necessarily want). Using these two industry groups can provide another key “heads-up” when there is another major downturn building.

Bottom Line:

By using the movement of safe-haven assets, investors can remove the “scare factor” that is often promoted and focus on the real events that are unfolding in the markets and hopefully make better decisions.

Donald W. Dony, FCSI, MFTA. Analyst, past instructor for the Canadian Securities Institute (CSI), editor for the www.technicalspeculator.com, dwdony@shaw.ca, 250-479-9463