Is This A Correction Or A Bear Market?

On Thursday of this past week, we hit a particularly oversold level in the stock market.  As the stats from Index Indicators pointed out, we had fewer than 10% of stocks in the Standard and Poor's 500 Index trading above their 3, 5, 10, 20, 50, 100, and 200-day moving averages.  In other words, the market was oversold on most every time frame that traders typically look at.

Now here's the interesting thing:  When this happened on August 8, 2011, the market ultimately moved higher by over 9% in the next 50 trading days.  To be sure, there were volatile upmoves and downmoves over that period as the market found a base early in October and late November of that year, but the basic direction was significantly higher by the start of 2012.  In December of 2018, we similarly hit a point where the market was oversold across all the aforementioned time frames.  Fifty days later, we were up more than 23%.  That very oversold level marked the bottom of the move to the day!

On the other hand, we first hit the broadly oversold level during the 2008 bear market on October 6th, with the SPX average at 1056.89.  Before the month was up, we had dropped another 200 points and eventually did not make a price low until March 9, 2009 at 676.53. In other words, oversold in the big bear market was followed by more oversold for quite a few months.  The value buyer in early October, 2008 was gored by the bear for another 30+%.

So now we've hit a broad oversold level this past week and bounced sharply the next day on news of policy interventions.  Have we seen the capitulation phase of a correction or is this simply part of a waterfall in a bear market?

As I am writing this, I am receiving numerous emails from colleagues describing the start of shortages at supermarkets.  I am also hearing from parents dealing with the closings of their children's schools and colleges.  And I am hearing from small business owners, such as restaurant entrepreneurs, that business is way down.  If that continues, we can count on layoffs and real economic pain. Small business and the service sector are important engines of the economy.  Increasingly, as Duke finance professor Campbell Harvey has noted, we're facing the likelihood of a nasty recession--and that's what rates markets are telling us.

Historically, important bear markets have taken months to find bottoms .  This happened between late May and late October of 1962; between August and late December of 1966; between January and June of 1970; between August and December of 1974; between October of 1981 and August of 1982; between October of 1987 and October of 1988; between August of 2002 and March of 2003; and of course between October of 2008 and March of 2009.

The virus has yet to run its course in the U.S.  We've yet to see any bond default and/or bankruptcy fallout from the recent energy spat between Russia and Saudi Arabia.  We've yet to see how well we succeed at flattening the pandemic curve and how well we succeed at providing adequate support for laid-off workers and battered sectors of the economy.  It's difficult to believe that public perception and psychology will change on a dime.  The lifestyle and economic impact of the coronavirus outbreak are likely to be with us for a while.  That is why I'm open to the bear market hypothesis and not betting my life savings on a V bottom.

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