Thursday, January 30, 2014
Stocks are not in a bear market yet. But they're headed in that direction.
The stock market has been forming an important long-term top for the past few months. We know this because market tops are made just about every six to seven years. The last top was in September 2007. So we're in the time frame for another right now.
Also, we're seeing the same sort of warning signs today that we see during every topping process. Specifically, long-term interest rates have spiked sharply higher over the past year. And investors have purchased a record amount of stock on margin.
But until this point, we've been missing poor price action. Despite the classic warning signs of an impending bear market, the S&P 500 continued higher into the end of 2013. It's only after the action of the past week that we can say the bear might finally be waking up...
Regular Growth Stock Wire readers know my gauge for defining bull and bear markets is how the S&P 500 is trading relative to its 20-month exponential moving average (EMA). If the index is trading above the 20-month EMA, stocks are in a bull market. If the index is trading below the line, it's a bear market.
Here's how the S&P 500 looks today...
The two red circles on the chart show the previous two times the S&P 500 dipped below its 20-month EMA and entered bear-market territory. (The stock market recovered quickly following the breach of the line in 2011, and a bear market never developed.)
Right now, the S&P 500 is about 190 points above its 20-month EMA. It's also only down about 4% from its 2014 high. So it's way too early to be calling this a bear market.
But it's not too early to trade like it's one. Let me explain...
Contrary to popular belief, traders don't make money in bear markets by shorting stocks aggressively and holding those short positions until the final panic that marks the bottom. There are far too many whipsaws, too many one-day-wonder rallies, too many counter-trend moves. In these conditions, traders usually short stocks aggressively into weakness. Then a strong counter-trend rally blows those positions up, and traders end up taking a loss.
Bear markets are brutal to both the long and short sides of the market.
The way to profit in a bear market is to focus on the short term, take advantage of extreme moves, and take profits quickly.
There will be opportunities to profit on moves in both directions, up and down. In 2008 – during one of the worst bear markets of our generation – my S&A Short Report subscribers had more profitable trades from the long side of the market than from the short side.
Bear markets are filled with emotional moves. Investors panic to get out when it looks like stocks are ready to fall off a cliff. They panic to get in when stocks start to bounce and traders fear they've missed the bottom. All that emotion creates volatility. It creates fast moves where indicators rapidly flip back and forth between oversold and overbought conditions. And it creates lots of trading setups for traders who are looking to anticipate those moves.
I expect 2014 will be a rough year for most investors. But it should be enormously profitable for traders who can adapt to bear-market conditions.
Best regards and good trading,
"A sharp and sudden rise in interest rates has always preceded an important top in the stock market," Jeff writes. "It happened in 1987, 1994, 2000, and 2007. And it looks like it's happening now..." Get all the details here: This Could Be Disastrous for Your Portfolio.
As Jeff mentioned, NYSE margin debt is at an all-time high. And this kind of leverage destroys investors. "Leverage is financial crack," he writes. "The first hit feels good. It's a trader's high... We want more of it. So we use it again, and again, and again – until we're addicted." Eventually, though, "it kills us." Learn more here.
Biotech uptrend keeps rolling as Biogen hits a new all-time high.
Cold U.S. winter sends natural gas soaring... prices rocket 50% in the past three months.
"Big Cheap Tech" giant Microsoft is up 35% over the past 12 months, including dividends.
Gold draws a "line in the sand" at $1,200... prices are up about 6% off last month's lows.