Bull Or Bear Market?
By Cory McPherson | April 2022
The volatility that began at the beginning of 2022 has not subsided. While the market was able to recover some of its losses in the month of March, it has given it all back so far in April. We are back to the levels from late February/early March across most major indexes, making this an important point in time for the stock market. Do we see a bottom from here, or does the market continue to break down? We show what areas of the market and economy we are watching, what our indicators are showing, and what could make the case for this bull market to continue, and the case for why we may be shifting into a bear market.
A Look at the Market
The chart above takes a look at the S&P 500 index going back a full year. As you can see in early March, the market bottomed around 4200 before staging a rally. We are now back to that point and re-testing that bottom. You’ll also notice the index is now basically back to the point it was a year ago.
Below is a chart of the Nasdaq, the technology heavy index which has been the darling of the stock market not only since the Covid crash of 2020, but since the start of this bull market run back in 2009. You can see it is also back down to its lows from March. You’ll also notice this index is now negative for its 1-year.
Reasons To Be Optimistic
One reason is looking at the charts and where we are now. As noted above, we are back to levels where the market bottomed earlier this year before a rally. Another rally from this range would be a positive sign, and a possible sign that a bottom is in for the near-term. We would want to see it get back above its moving averages and clear resistance that has formed around 4600 on the S&P. As we’ve seen before, rallies can happen quickly, and a sharp bounce off of current levels would not be a surprise. Any rally in the market would need to see some of the more aggressive sectors of the market leading, such as technology, consumer discretionary, and communications. This would show investors are willing to take more risk, and not just positioning into more defensive areas, as has happened for most of this year during rallies. If we were to see this happen, investors becoming more willing to take risk, it would give reason to believe this is just a correction and not the beginning of a bear market.
One of the main reasons to be optimistic, is because just about everybody is pessimistic right now. Investor sentiment is at levels that typically have marked bottoms and great buying opportunities since this bull market began in 2009. When everybody gets on one side of the market, it typically will move in the other direction. Being a contrarian in this sense has typically paid off. One way to measure sentiment comes from the American Association of Individual Investors. It surveys its members weekly to see if they are bullish, bearish, or neutral. Data from April 21st showed only about 18% are bullish, while over 43% are bearish. The chart below shows the spread between bullish and bearish investors surveyed in relation to the S&P 500 index. When it comes to sentiment, it can change quickly, as the chart shows. If we did see a strong rally from here, you would most likely see sentiment improve rapidly and remove this as a case to be optimistic.
Another reason to be optimistic in the near term, is because of the Federal Reserve rate hiking cycle that has started this year. Yes, history tells us that when the Fed begins their rate hiking campaign, it will most likely end badly for the market and the economy. However, history also tells us that the market typically goes up while the Fed hikes rates. It’s when they get done hiking rates that the market typically falls apart. The below chart shows the S&P 500 total return in relation to the effective Fed funds rate going back to the early 1980’s. The shaded areas highlight the returns of the S&P during rate hike cycles.
The Bear Case
Just as the charts show a reason to be optimistic if we can bounce from here, if these levels fail then the market could have much further to fall. Using technical analysis and Fibonacci retracement levels, a break below current support could see the S&P 500 falling to 3500-3800. We’ll be watching different areas of the market that can sometimes be leading indicators of the market and economy as a whole. One of those areas is the transportation sector, which we have highlighted before. The chart below shows the iShares Transportation Average going back 2 years. You can see the run up it had at the end of 2020 through May of last year. Since that time, we’ve seen it consolidating sideways without a trend. Currently it is sitting on the bottom of the range that has formed through this consolidation, and any breakdown below that could spell trouble.
Another area of the market to follow is Semiconductors. It’s not only a big part of the technology sector, but it has also become somewhat of an indicator on the health of the overall market and economy, as just about everything requires a computer chip. Over the past year there has been plenty of talk about supply chain problems and shortages, and semiconductors have been one of the biggest problems. The below chart shows how semiconductors have done over the last 2 years. After a strong rally to end 2021, it has rolled over and broken below its low it had in March, unlike the overall market. This gives reason to be cautious about the overall market. If both transports and semiconductors continue to trend down, that would spell trouble for the overall health of the economy going forward.
The Fed, interest rates, and inflation can all be tied together as well for a reason to be bearish. As stated in the bull case, the Federal Reserve has begun its rate hiking cycle this year. While we highlighted how that can be bullish for the stock market during the rate hike cycle, we also noted how when it ends, it typically ends badly. What’s different about this cycle compared to the last few, is the extreme levels of inflation. The stated goal of the Fed this year with their rate hike campaign is to tame inflation. The stock market since 2009 has become built on very low interest rates and quantitative easing programs from the Fed (provide liquidity). Any time the market has come under turmoil, the Fed has stepped in to help. There’s reason to believe that may not be the case this time if inflation remains stubbornly high. The Fed would have to choose a side, do they stick to their word and continue raising rates to try to tame inflation? Or do they cave to the stock market, keep rates low, and start injecting liquidity into the system again? The Fed has backed themselves into a corner and appear to have made it nearly impossible for them to orchestrate a “soft landing” for the economy and markets.
Our base case to be bearish at this point is our indicators, specifically our long-term indicator. We highlighted this earlier this year when it turned negative, and it currently remains negative, as shown below. As you can see over the last 22 years, this isn’t something that flips back and forth positive to negative very often. This being just the 5th time turning negative since 2000. Our short and intermediate term indicators are also currently negative. If we see those turn back positive, that could give us reason to take some more risk in areas. But currently with all indicators being negative, that gives us good reason to be defensive.
Going Forward
We’ll continue to rely on our indicators and charts to help guide our decision making. As stated above, they give us reason to be cautious and take less risk at the moment, as they have for most of this year. There are different scenarios, both positive and negative, for the market we could see play out. Instead of predicting, we’ll wait and see and adjust as needed. 2022 has been a challenging year and we believe it shows why having an active approach to investing works.
Cory McPherson is a financial planner and advisor, and Senior Vice President for ProActive Capital Management, Inc. He is a graduate of Kansas State University with a Bachelor of Science in Business Finance. Cory received his Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services in 2017.
Disclosure