(Important Note: This article was first published on March 4, 2016. It became one of the most talked about articles on Zacks.com in years. So I am bringing it back by popular demand to remind investors of the bearish forces at play.
I am republishing the original article in its entirety. However, where appropriate, I have added an "Update" section to share new insights.)
Right now there is a tug of war going on between bulls and bears. That explains the violent drop to start the year followed by an equally impressive bounce. That same chain of events took place last year August through October. Yet by my estimation the bears are winning the war. And now after this latest bounce is the perfect time to grab the rope with them for the next pull lower.
So yes, my goal is to get you to appreciate the bear argument to make changes to your portfolio. Not just to survive, but thrive in this environment that will likely last another 6-12 months.
That's because sticking your head in the sand to wake up to 30-50% losses is not an effective strategy. Hiding in cash is better...but why do that when there are ample profits to be made riding the bear to the finish line?
There is no singular data point or piece of evidence that guarantees that a bear market is on the way. Rather it is about assembling a case where the preponderance of the evidence points to the verdict.
In my recent commentary for the Reitmeister Trading Alert I have pointed out more than a dozen bearish arguments. However, putting them all here today might take the better part of the weekend for you to read. Instead I am going to share with you the 4 best reasons to get bearish now.
1) Bear Markets Are More Common Than You Realize
As human beings we are hard wired for pain avoidance. With that you see many investors trying their best to rationalize why a bull market will stay in place even when the odds keep stacking up against them.
Part of the problem is that most investors don't really appreciate how commonly bear markets occur. Yet as this chart shows you, there have actually been 25 bear market drops of 20% or more the last 87 years.
We all know that night follows day. Just as well bear markets follow bulls. The timing of which is just less certain. So with this being the 3rd longest bull market over that same 87 year stretch, it says that we are getting pretty close to the end.
(Update: If the bull extends into June it will become the 2nd longest bull in history. Older bull markets are usually celebrated with selling and not a birthday cake and presents ;-)
MORE . . .
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2) Earnings Recession
Look at this long term chart showing the EPS for the S&P 500 compared to the movement of the underlying stock index. You will notice that earnings rarely go sideways for any extended period of time. They are either trending up or trending down. And once the earnings start heading south so too does the market.
As you can see by this chart the earnings picture has likely already peaked and starting to come down. Given history it says it will only get worse from here.
(Update: Indeed Q1 earnings showed a further extension of negative growth. Estimates for Q2 earnings have been trimmed as well.)
3) Technical Picture
There are so many different flavors of technical analysis and it's easy to find one that contradicts another. However, one of the most time tested forms of technical analysis is the Dow Theory. Few models have a better track record for aligning investors with the long term trend than this indicator.
As it turns out the Dow Theory sell signal was issued in January 2016. And 60% of the time that signal is followed by a bear market.
Again, nothing in the world of calling a bear market is foolproof. But 60% likelihood of calling a bear market on this indicator, plus the rest of the evidence, starts to get pretty convincing.
(Update: The Dow Theory Sell Signal has been reversed. Then again, with many false signals the past few years I am beginning to suspect that its usefulness is waning. That is especially true for a measurement system created well before computer based traders made up 50% of all trades. They have changed the shape and volatility of the market and thus calls into question the validity of this older system of technical analysis.
A simpler view is to point out that the last high for this bull market was made May 21, 2015. Yes, a full year ago. And 8 of the last 11 times the stock market has gone this long without making a new high it was because it was rolling over into the start of a new bear market.)
Academic research is very clear on this point.
Low PEs = fertile soil for future stock advances.
High PEs = low odds of investment success.
The chart below, based upon the Shiller PE measure, proves this out. And right now the Shiller PE stands at 25.
You may be looking at the 10 year return of +0.9% and saying to yourself "what's the big deal...it's not negative”.
The big deal is that the market never goes sideways for a long period of time. The only way to come out with a return so low is to have a bear market or two mixed in to drive down results. This is pretty much what happened after the tech bubble of 1999 and how the next decade gave virtually no gains to stock investors thanks to two nasty bear markets.
Indeed the current valuation picture says that a bear market should soon be on the way to cut stocks down to size.
(Update: The only way to look at the stock market and find value is through the Earnings Yield looking glass, which shows a reasonable valuation versus the 10 year Treasury rate. And that is only because we are at historically low rates. However, this week investors finally got the message that the Fed does truly intend to raise rates. Thus, with rates moving higher, even that view of value is starting to wane.)
What to Do Next?
As you can see from the evidence, the bear is headed our way. I urge you to prepare for it in advance. Don't just bail out or ride it out. You have a unique opportunity to make substantial profits from it.
That's why I am inviting you to download my Bear Market Manifesto free.
This Special Report provides additional information that could prove critical to your portfolio in the weeks and months to come. Most importantly, it reveals the stock market strategy I encourage you to trigger as soon as the downturn strikes in earnest.
The time to start preparing is not next month, not next week, but today. Your free opportunity to see the Manifesto ends midnight Sunday, May 22.
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Steve is the Executive VP in charge of Zacks.com and all of its subscription services. His personal mission is to help investors achieve life-changing investment success by harnessing the power of earnings estimate revisions. Over the years, he has developed a full array of services to help investors do just that. Discover all of these services now to find the ones that perfectly fit your investment style. Learn more about Zacks Ultimate.