This is what the beginning of a bear market looks like

December 21, 2018

This is what the beginning of a bear market looks like

In the last week, bearish momentum has really started to pick up. This entire year has been punctuated by volatility driven by uncertainty, but it’s really only since late November that the overall market tone has actually started to turn negative. That fact has finally come to bear this week, forcing the S&P 500 below an important support level near its yearly lows around 2,600. Until this week, the market had managed to hold up pretty well in correction territory, using that support to bounce and move higher on multiple occasions – until now.

The market still isn’t in official bear market territory – the S&P 500 is still only down a little over 13% – but the truth is that a deepening correction, followed the most extended bullish market in recorded history is a very real indication of increasing risk. In fact, if history is any indication, I think that this week has marked the actual beginning of the next bear market. This prediction is admittedly premature, because while the market is in actual short-term downward trend right now, that drop has to push more than 20% off of its highs before anybody can officially call this a new bear market. There are some elements of the beginning of the Great Recession in late 2007 that bear interesting similarities to today’s market. Those elements start with something that technical traders and analysts like to call consolidation.



Consolidation ranges are useful within longer trends, because they provide the market with time to reevaluate the strength and health of that trend before taking the next step. If you’re paying attention to those levels, and to the distance between the top and bottom end of that range, you can identify near-term trading opportunities.

Breaks out of consolidation ranges can be interpreted in pretty straightforward terms. Breaks above the top end of a consolidation are almost always a bullish indication, while breaks below the lower end of the consolidation are almost always bearish. Consolidation ranges also tend to become more useful at the extreme end of a long-term trend; for example, it was a break below a consolidation range in early 2008 that confirmed the start of the Great Recession. That bearish break below a consolidation range helps to provide the context that I want to apply to the market’s current conditions. Let’s start by looking at that pattern.

I’m using the horizontal red and green lines on the chart above to demonstrate the market’s consolidation range at the top of the bull market that finally ran out of gas in late 2007. The bottom of that range held up nicely in October and again in December 2007, but finally saw the market “bend over” and break below it at the beginning of the year. It’s interesting that one of the technical elements that technicians should have recognized at the time as an early indication bullish sentiment was finally giving bearish way is the lower pivot high I marked with the dashed orange line. That’s a downward “stair step” that is a standard component of a short-term downward trend. The break below that consolidation range confirmed that trend and pushed the market into the last bear market.



Now let’s take a look at the market as of right now and compare what we’re seeing. I think the similarities are worth paying attention to.

 

This chart covers the last three years of market activity, because I want to try to put the market’s movement since the end of September in the most complete context possible. The horizontal green line on the chart shows the support level the market had been using repeatedly throughout the year to stabilize and look for new reasons to move higher. I’ve only placed the bottom line of this year’s consolidation range because the break that we can see happened this week looks very similar to the consolidation break at the beginning of 2008. It is also marked by a downward “stair step” pattern from the market’s high in September to the top of November’s consolidation range. That stair step – just like the one that showed up in late 2007 – is what I think is going to keep pushing the market lower.

There are some interesting emotional elements at play right now that I think illustrate the way market commentary and focus seems to be shifting. Instead of trying to look for positives to keep things stabilized, or moving higher, I’m starting to see a lot more conversation, analysis and speculation about how bad things could actually get. The market is starting to look for reasons to stay bearish, and in my experience is something that can often create a self-fulfilling prophecy; investors are afraid the market is going to keep going down, so they start selling more and more, which means that the market has to keep going down.

The Fed yesterday raised interest rates for the fourth time this year, as expected; but they also seemed to try to use a more accommodative tone about the economy, suggesting that rate hikes in 2019 could be fewer depending on new economic data at that time. The market’s reaction was to shrug any hint of silver lining in the news and keep selling. The prospect of a government shutdown has only added to the angst this week, and this morning news broke that the U.S. and the U.K. are combining forces to accuse and charge China of waging a sustained campaign of focused cyber theft of commercial intellectual property. The monster looks like it could be starting to consume itself.