Wall Street has had a wild ride over the last week. Two weeks ago I warned that several stocks had already entered their own bear market. If this is indeed the beginning of a full-on bear market, it’s only getting started. Even with all the selling, and the rally today, I still believe it’s too risky to allocate anymore capital to equities.
Bear markets have two interesting features that make them different from bull markets, besides the obvious downward trajectory:
- Volatility is much higher.
- There are more days when stocks trade up sharply higher.
That second one might seem counterintuitive. Why would there be more large “up” days when the overall trend is pointing down?
Reason is, more people like to at least try to call a bottom than call a top. You can make money off calling a bottom (if you’re right).
When those people plug back into the market after a selloff (like today, with U.S. stocks up 4% higher), they can drive it sharply higher – again, sometimes much higher than you might find in a regular ol’ bull market. And it’s these sharp turns that make volatility so much higher as well.
It’s this combination of bottom fishing and these big “up” days that lull investors back into complacency… right before the next smash.
Where the Market Is Now
I write all this because the recent market price action is decidedly bearish. Many indices like the S&P 500 and many individual stocks are falling on much heavier volume – much more volume than when they were rising. Like Harry says, bubbles burst much faster than they inflate.
Several factors are at play here.
For one, market fundamentals have been weak for some time. The market had continued climbing, despite the fact that economic growth had been downgraded… household liquidity had been drying up… and that U.S. markets were among the most overvalued among the major markets globally. They still are. A 10% to 15% decline isn’t going to change that.
Yet there’s another dangerous warning sign in the fundamentals – the downward trend in earnings estimates.
Warning Signs: More Trouble Ahead!
Earnings have been poor this year. To meet their goals, I’ve seen many companies in the earnings report shift their revenue goals to the latter half of the year.
I’m skeptical.
When a company has to depend on the second half of the year to meet its revenue goals, more often than not, management is kidding itself. How optimistic to think business will re-accelerate after it’s begun to slow!
Part of what’s driving these downward estimate revisions is plummeting oil prices. According to Ned Davis Research, the second quarter – whose figures are still being finalized – has a projected drop of 10.6% in consensus year-over-year estimates on the S&P 500. They also point out that’s the largest drop since Q4, 2009!
But it’s not just energy. Though it might be leading the pack with a 13.8% drop in estimates, estimates for every sector are being slashed.
Then there’s the fact that weak hands hold stocks now. After a number of investors have aggressively bought stocks on margin, this could be another catalyst for another big leg down.
Take those warning signs and the fact that valuations are still frothy, and you can expect much more volatility in the near future. This recent stock market slide is only the beginning. Prepare for more wild rides ahead!
John Del Vecchio
Contributing Editor, Dent Research
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