The Stock Market Has Avoided a Bear. But the Selloff Isn’t Over.
The S&P 500 indexSPX +0.01% refuses to fall into a bear market—but that doesn’t mean it’s found a bottom just yet.
Not that it wasn’t a painful week. The S&P 500 dropped 3% and has now fallen 18.7% from its Jan. 3 all-time high. A slide of 20%, which it touched Friday before bouncing back, signifies a bear market. The Dow Jones Industrial AverageDJIA +0.03% declined 2.9%, its eighth consecutive week of losses, matching its longest losing streak since 1932. The Nasdaq CompositeCOMP –0.30% , already in a bear market, slid another 3.8%, and is down 28.2% from its early January peak.
With losses like that, we’d expect to find an end-of-the-world headline that drove the selloff, but good luck finding any single trigger for the week’s carnage. Instead, it was an accumulation of news that seemed to weigh on the markets. Federal Reserve Chairman Jerome Powell spoke about the need to keep raising interest rates, while Target TGT +1.26% (ticker: TGT) and Walmart (WMT) not only reported earnings that disappointed but offered commentary that suggested U.S. shoppers are finally feeling the impact of rising prices.
Photo illustration by Barron’s Staff; Getty Images (2)
Perhaps the only good news was a strong retail sales report, though that was also bad news in an environment in which the Fed needs to slow growth to combat rising inflation.
Ultimately, there was no place to hide, and even previously strong performers seemed to finally capitulate. The Dow Jones Transportation Average dropped 6.7% on concerns over a shipping recession, after having declined just 12% entering the week. The Consumer Staples Select Sector SPDRXLP +0.21% exchange-traded fund (XLP) entered the week nearly flat on the year, but dropped 8.1%, with Procter & Gamble (PG) falling 7.7% and Hershey (HSY) tumbling 8.4%. “When you can’t hide in Hershey, you pretty much can’t hide,” says Frank Gretz, market analyst at Wellington Shields.
And for good reason. Walmart and Target aren’t just anybody. They’re not highflying tech stocks with nosebleed valuations and no profits or weak businesses just trying to scrape by. They are among the best-run companies in the U.S., and they’re demonstrating that it’s nearly impossible to manage well through the current environment of high inflation, supply-chain disruptions, a tight labor market, and rapidly shifting consumer preferences.
But the big drops in previous winners could be good news, if it means that investors are finally capitulating and bringing the market closer to that elusive bottom.
“In order for pessimism to reach true panic levels, investors need to fear there’s no place to hide,” says Ed Clissold, chief U.S. strategist at Ned Davis Research. “And that includes even some viewed as untouchable companies.”
Other signs of a possible bottom nearing are starting to emerge, as well. The S&P 500 now trades at just 16.6 times 12-month forward earnings, down from 21.5 times at the start of the year and “only a touch above the long-run average,” writes Manish Kabra, head of U.S. equity strategy at Société Générale. “The correction has literally vaporised the valuation froth in the S&P 500.”
Looking for more? Sentiment is also at ridiculously low levels—and that usually suggests it’s time to buy. Michael Hartnett, chief investment strategist at BofA Securities, noted that the BofA Bull & Bear Indicator recently tumbled to 1.5 from 2.0, putting it in “unambiguous contrarian buy territory.”
That wasn’t enough for Hartnett, however, who explained why the market is likely to fall even further. Over the past 140 years, U.S. bear markets have lasted an average of 289 days and fallen 37.3%. That would put a bottom for the S&P 500 at around 3000, down 23% from Friday’s close of 3901.36.
A bottom might be closer than that, however, especially if one thinks in terms of waterfalls, not bears—not because rushing water is relaxing in turbulent times, though it is, but because that’s what this selloff has come to resemble. Ned Davis’ Clissold defines a “waterfall decline” as one with persistent selling, big bounces that don’t last, and then, even more selling. Historically, they’ve lasted about 40 calendar days, with an average drop of 24.6%, while also seeing a surge in trading volume. The current decline has been long enough but not deep enough, so he isn’t recommending buying stocks just yet. “We don’t adhere to catching falling knives,” he says.
Clissold knows what he wants to see—a couple of days of strong buying, when gainers outpace losers by 10-to-1, with no 10-to-1 down days in between. “The selling pressure needs to transition to persistent buying pressure,” he says.
There are other signals to watch for a bottom. Evercore ISI strategist Julian Emanuel points to the Cboe Volatility Index, or VIX, topping 40, a put-call ratio over 1.35, and a large volume day, perhaps one that exceeds January’s peak, as signs that the selloff is nearing its end. What investors don’t want to see is persistently strong retail sales or other signs that the Fed will have to stay aggressive with rate hikes and quantitative easing. “The Fed has this incredibly difficult balancing act to pull off,” he says.
When the bounce does come, don’t be surprised if it is explosive. For instance, the S&P 500 has fallen for seven consecutive weeks. Following the end of its three previous losing streaks of seven weeks or more, the index went on to gain an average of 39%, observes Frank Cappelleri, chief market technician at Instinet. “While the historical sample size is small, when the previous long losing streaks ended, they were followed by exceptionally strong rebounds—regardless of the current market’s overall trend,” he explains.
We’ll be waiting.