Saturday , 22 September 2018

Take Note: These 11 of 19 Bear Market Warnings Have Been Signaled Already

 As you can see from the image below, 11 of the 19 bear market signposts havebear been triggered already.

 

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(Click on image to enlarge)

1. Fed raises rates by more than 75 basis points.

Since 1982, every bear market has been preceded by over 75 basis points of rate hikes. The Fed has already raised rates by 125 basis points in this cycle so that has been met but we aren’t [even] at the end of the rate hike cycle yet.

The current estimate on the CME Fed Watch tool has the most likely (75%) scenario being that the Fed will raise rates twice by December 2018. The second most common expectation (39.5%) is 3 rate hikes…

2. Credit conditions tighten.

This signpoint hasn’t been triggered. The last 3 bear markets have started with the C&I lending standards tightening…[but it] has been strong this year…[albeit] slightly off the high set in October.

We’d need to see a few bad months is a row before anyone would worry about a recession.

3. Trailing 12 month returns in the S&P 500 are over 11%.

In 92% of the periods before bear markets (going back to 1936), the trailing 12 month returns in the S&P 500 have been over 11%. With the returns at 19.7%, that trigger has been met.

I don’t think of this as a great warning sign because while bear markets have often occurred after excess returns are realized, stocks have rallied many times without a bear market following soon afterwards.

4. The S&P 500 returns over 30% in the prior 24 months. 

In 92% of the periods before bear markets, the S&P 500 has returned over 30% in the prior 24 months. My opinion on this point is the same as the last one. Stocks may increase a lot before bear markets, but they also increase a lot during bull markets. This means I think indicators #3 & #4 so far are bunk.

5. Low quality stocks outperform high quality stocks.

The S&P 500 stocks with quality ratings of B or lower have outperformed the stocks with quality ratings of a B+ or higher in 100% of the periods before bear markets since 1986 but that event hasn’t been triggered yet as the S&P 500 quality index (determined by the return on equity, the accruals ratio, and the financial leverage ratio) has increased 6.21% in the past 3 months…

6. Momentum stocks outperform the market.

This signal is flagged when the top decile of stocks with the best price returns in the S&P 500 beat out the S&P 500 equal weight index. Since 1986, this has a 100% hit rate and this time round is no different as this signal has been hit

7. Growth stocks outperform the equal weight index.

…This indicator has worked 100% of the time since 1986 and this time round is no different as this signal has been hit…Growth names have outperformed the S&P 500 by 2% in the past 6 month and the past 12 months. When both growth and momentum stocks outperform the market, it’s an indicator that speculators are driving the market higher.

8. The number of times the S&P 500 has pulled back by 5% in the past 12 months.

…I don’t consider this to be a viable indicator. Yes, some volatility in the midst of a rapid rally is a sign of a coming bear market, but 5% is too little to matter. Either way, this indicator hasn’t been hit as there have been zero 5% correction in the past 12 months. Since 1928, this indicator has a hit rate of 92%. Only the 1961 bear market didn’t have a 5% selloff prior to its start.

9. Low price to earnings multiple stocks underperform over 6 months and 12 months.

They have underperformed by 4% over the past 12 months, but they have outperformed by 2% over the past 6 months, so this signal hasn’t been triggered. When the top decile of firms with the highest earnings yields underperform the equal weight S&P 500 index, the hit rate for bear markets is 100% since 1986.

10. The conference board consumer confidence index is above 100 within 24 months of every bear market since 1967.

This signal has been triggered as consumers have been very confident this year…[but] I think it will fall in the near term because of negative sentiment surrounding the GOP tax plan… As you can see from the chart below, the consumer confidence expectations index has had a sharp drop. It is now at the lowest level since right after the Presidential election.

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Conclusion

I think 3 of the 10 indicators I reviewed above aren’t valuable. That would mean 9 out of the 16 bear market signals I have identified have been triggered if you assume the others that I didn’t review are all viable. We’ll see about that in the next article.

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