The stock market, once thought to be on solid ground, has recently revealed significant vulnerabilities. Last week, the S&P 500 experienced a 2.67 percent drop from open to close. For July, it recorded a decline of 1.63 percent, marking its first monthly loss since January.
A multitude of factors were cited for this downturn. Issues such as the Argentine debt crisis, US and EU sanctions on Russia, and the potential for rising interest rates from the Federal Reserve all played their part. However, at Economic Prism, we hold different views—these events should not have caught seasoned investors off guard.
In our perspective, the decline in stock prices can be attributed to a more straightforward reason: it’s simply what the market must do. The stock market naturally ebbs and flows, and after a sustained upward trend lasting five and a half years, a downward adjustment is overdue. The extent of this decline? That remains uncertain, but it is likely to be more than just a minor dip.
As the saying goes, “History doesn’t repeat itself, but it does rhyme,” suggesting we should examine past trends for insights into the future…
A 38 Percent Average Decline
Mark Hulbert of MarketWatch states, “Over the past 45 years, the stock market has experienced declines of over 20 percent each time three warning signs appeared simultaneously.” Following last week’s selloff, which drove the Dow Jones Industrial Average into negative territory for the year, it’s noteworthy that all three signals are currently evident.
These indicators include excessive bullish sentiment, significant overvaluation indicated by high price/earnings ratios, and extreme discrepancies in sector performances. According to Hayes Martin, president of Market Extremes, this trifecta has coincided six times since 1970.
On those occasions, the average subsequent decline in the S&P 500 was 38 percent, with the smallest drop recorded at 22 percent. A bear market is defined as a drop of at least 20 percent, and bullish markets are characterized by increases of at least 20 percent.
Moreover, no bear market has initiated without these three indicators being present. Martin also notes that once they appear, a decline typically begins about one month later.
In summary, the average drop following such signals is 38 percent, which could position the S&P 500 around 1,230. However, further declines are certainly possible…
This Bull Market is Cooked
Given the extensive rise and duration of the current bull market, a subsequent drop is likely to exceed average predictions. Additionally, should the financial support provided by the Fed falter, stocks might plummet rapidly. Further historical indicators also suggest that a decline is imminent.
For instance, veteran investor Mark Cook, featured in Jack Schwager’s acclaimed book, “Stock Market Wizards,” and winner of the 1992 U.S. Investing Championship, believes that the U.S. market faces significant challenges, as reported by another MarketWatch article.
Cook’s primary indicator, the “Cook Cumulative Tick,” measures NYSE Tick in conjunction with stock prices and successfully predicted the crashes of 1987, 2000, and 2007. This indicator also signaled the bullish market’s beginning in April 2009 when it showed unexpected growth.
What is Cook’s current assessment? “There have only been two instances of significant divergence between the NYSE Tick and stock prices: in early 2000 and mid-2007. The third instance occurred in April 2014,” he explains. This divergence is a concerning signal for market vitality and suggests that the Cumulative Tick now indicates a looming bear market.
In essence, Cook’s findings imply that this bull market is indeed nearing its end. While the future may hold uncertainties, it might be wise to secure some profits. The remarkable surge in the market over the past five years cannot last indefinitely—history demonstrates that bull markets eventually come to a close.
Sincerely,
MN Gordon
for Economic Prism
