IS MARKET WINTER COMING?

Two previous bull markets ended in a similar fashion

In last month’s technical column of Investors Monthly I highlighted the fact that the bull market in SA and global equities was getting very mature and that a potential end to the bull market was in sight.

A month can be a long time in financial markets and the month from mid-August to mid-September has seen a dramatic shift in the state of global equity markets. A global equity sell-off ensued following a move by the People’s Bank of China to devalue the Chinese currency. This was a drastic move which was unexpected and has cast doubt over the health of the Chinese economy. Given the significance of the Chinese economy to the rest of the world, it is no surprise that markets have been rattled by this sudden realisation that China may not be the saviour of global economic growth after all.

The weekly chart of the S&P500 that is presented here shows three bull markets and two bear markets that have occurred since the mid-1990s. The world’s largest and most closely watched stock index has made a significant break below the uptrend that joins all the lows since the start of the bull market in 2009.

This looks very ominous when compared to how the prior two bull markets ended. Both the bull market that led up to the dot-com bubble bursting in 2000 and the bull market that led up to the financial crisis in 2008 ended with sudden sharp breaks below the bull trends that had characterised those two bull markets. These trend line breaks were also combined with meaningful breaks below the 50-week moving averages. Following the breaks below the uptrends and the breaks below the 50-week moving averages, the market gave a sudden sharp throw-back to the underside of the 50-week moving average.

However, those throw-backs were insufficient to surpass the 50-week moving average and the market succumbed to more selling pressure. This failure to challenge the prior bull market higher is caused by sellers who failed to sell at the market top, viewing the throw-back as an opportunity to lighten or exit their holdings at a reasonable level. It also comes at a time when the rhetoric in the market has become decidedly more cautious.

In both prior cases, the S&P500 suffered sharp bear markets after the bull trend had been broken. Currently the chart setup on the S&P500 is of concern and if the past is any guide, it is quite possible that the prior bull market has ended.

We’ve seen the market break below the uptrend that began in 2009 on the move below 2 050. If the market follows the same pattern as the prior two topping out phases, then it’s likely that we will see a sharp throw-back up towards the 50-week moving average at 2 050 before further selling persists. What happens next is critical and will be an important indication of whether the bull market is in fact over.

A failure to break convincingly above 2 050 on the S&P500 will likely be the signal to indicate that further downside is likely and that a new bear market may be starting. If this is the case, then the big support on the long-term chart comes in at 1 550. That’s some 30% below the recent market peak of 2 130. A 30% pullback would be a relatively shallow bear market when compared to the bear markets of 2000-2003 and 2007-2009.

Typically, bear markets are a lot sharper and more dramatic than bull markets. The market falls much faster than it rises, which is why bear markets generally don’t last as long as bull markets. The warning signs are clear and there is no doubting that the tone on equity markets has shifted recently. “Buy the dips” seems to be a forgotten strategy now and there is generally a lot of nervousness in the air. This, combined with the technical damage that has happened recently, suggests that the winter season may have arrived for the world’s biggest stock index.