Could there be a simple explanation for the autumn wave of Bigfoot sightings? Is that creature actually The Bear? The footprints of a bear market look familiar…
The economic chaos in the Eurozone and its bear market keeps getting worse. American exporters rely on their European customers to increase demand for American-made products. Unfortunately, on November 15, Eurostat reported that third-quarter GDP fell by 0.1% in the Eurozone. The latest reading followed a second quarter which brought 0.2 percent contraction. The current result places the Eurozone back into recession, as most economists consider two consecutive quarters of economic contraction as the criteria for determining that a recession is taking place.
The fiscal cliff threat is rather hard to ignore. Investors are exposed to an unending loop of news reports concerning the latest impasse or pushback in the contentious negotiations to avoid the dreaded sequestration. Federal Reserve Chairman Ben Bernanke offered the following warning at his press conference in connection with the announcement of QE3 on September13:
If no action is taken, there’s going to be a very substantial increase in taxes and cuts in spending on January 1 of the coming year. The CBO has suggested that if that’s allowed to take place, that it would cause unemployment to begin to rise, and it might throw the economy back into recession and it’s easy to see how a new bear market could be the unfortunate result. Read: Even Without The Fiscal Cliff, A Recession Still Looms
It’s hard to muster the enthusiasm to shell out one’s hard-earned money to take a chance on our government’s ability to avoid a financial disaster. As a result, trading volumes are low. Beyond that, if you subtract the high-frequency trading chatter of computer-generated exchange traffic, you would be turning over a rock which might reveal how rotten the trading volume really is.
The technicals behind the market are dismal. On November 16, the S&P 500 Index closed at 1,360 – staying below its 50-day moving average of 1,430 and its 200-day moving average of 1,382 (NYSEARCA:SPY). Worse yet, a look at the S&P chart will reveal a triple top, signaling a serious risk that the index could make a further decline. The 180-day Nasdaq 100 chart is basically a giant head-and-shoulders pattern with SELL written all over it. Ditto for the Nasdaq Composite.
chart courtesy of Stockcharts.com
Not to be forgotten, the Dow Jones Industrials chart presents us with a triple top and a 200-day moving average that is so far above the most recent closing level that it resembles the contrail of an airplane flying over a small house. Four hundred points above the November 16 closing level might as well be 40,000 feet. These indicators are often early warning signs of an impending bear market in stocks and ETFs.
The slowing economy in China was best explained by the Dallas Fed in its August Economic Letter: China’s Slowdown May Be Worse Than Official Data Suggest:
When China’s average GDP growth remained above 9 percent in 2011, hopes rose that a sustained recovery would prop up the world economy amid the European sovereign debt crisis and subpar growth in the U.S. However, China’s economy deteriorated rapidly in 2012, with GDP growth slowing to 8.1 percent in the first quarter from 8.9 percent at year-end 2011. Second quarter GDP growth slid further, to 7.6 percent, the lowest reading since the height of the global financial crisis in early 2009.
Even with the decline, there is speculation that these figures may still understate economic slowing. Economists have long doubted the credibility of Chinese output data.
If China cannot prop up the world economy, what other nation is left to pick up the slack and prevent a new bear market?
The latest earnings report season was painful to watch. With nearly 500 companies’ having released their reports, the number of companies which actually beat their quarterly revenue expectations was just over one-third of the total. Revenue was the tough area, as just more than half of the reporting companies were able to beat their expected earnings number – usually by just a penny per share. The management guidance has been grim. In fact, any optimist who paid close attention to the guidance included in third quarter earnings reports would have been easily converted to Church of Pessimism. Read Economic Trend Update
A Bigfoot sighting would be nice . . . But if it looks like a bear and smells like a bear market, it could be The Bear.
The next question concerns what we can do to keep Yogi from taking away our “picnic baskets during a bear market decline”?
Here are some ideas used by the pros that one can consider for any portfolio:
1. Staying on the sidelines until The Bear and his bear market leaves is an easy strategy. Using stop loss points to get there can help. Many investors, who are in the habit of vigilantly watching market performance, lack the self-discipline to restrain themselves from “jumping back into the water”. Brushing up on the old self-discipline could help such individuals to bank some coin.
2. Using protective put options to hedge long positions without the need to bail out for a low price offers the investor a nice “insurance policy during bear markets.”
3. Not trying to “average down” by purchasing more of a stock after a price decline to dilute the magnitude of a loss. Numerous studies have proven that this is a bad strategy for the simple reason that the stock will – more often than not – continue to sink. It’s a classic example of throwing good money after bad.
Following the “rose colored glasses” crowd when your computer screen is covered with red numbers is usually not a good idea, particularly since there are a number of investments available which allow an investor to actually profit from a bear market.
Consider the following ETFs which move in the opposite direction of the underlying index and so can offer the potential for bear market protection:
ProShares Short Russell 2000 ETF (NYSEARCA:RWM)
ProShares Short S&P 500 ETF (NYSEARCA:SH)
ProShares Short Dow 30 ETF (NYSEARCA:DOG)
Another alternative is the AdvisorShares Active Bear ETF (NYSEARCA:HDGE). Active Bear is an actively-managed ETF. Its purpose is to help investors benefit from adverse stock market conditions by short-selling a portfolio of mid-cap and large-cap exchange-traded equity securities and ETFs. Although it includes a management fee which slightly reduces return, it does not have the tracking error which requires inverse ETFs to be re-priced after each session. The daily re-pricing can compound against the investor who holds that position over time, while the underlying index moves against such a fund.
Bottom line: Regardless of whether the Sequestration Express takes us over the fiscal cliff, the other footprints of The Bear and possible bear market are hard to ignore. A careful investor can do more than simply hide the picnic basket from Yogi. There is plenty of “low-hanging fruit” out there waiting to be gathered by those who know how to dodge The Bear if he should once again emerge from his cave looking for a tasty Thanksgiving feast.