Declines into Bear Market Lows
Firstly, Mr Hester looked at how all the 19 bear markets in the US performed in the four week period preceding the final bear market low and then how the S&P 500 performed in the first five weeks of the ensuing bull market (see chart one).
This price behaviour is very important because, as I have pointed out in previous articles, secular bear market bottoms are characterised by investor revulsion rather than panic or fear as investors become so disillusioned with equities as an asset class that they throw in the towel. ( and ). Moreover, contrary to popular belief, these final lows are generally formed after modest market sell-offs in the final four weeks of the bear market. In fact, no fewer than 15 of those 19 bull markets (marked in blue on the chart) started after the index had fallen less than 10 per cent in the final four weeks of the bear market. Bearing this in mind, when the S&P 500 fell to its intra day low of 666 on 6 March it had declined 23 per cent in the previous 20 trading days. So if a secular bull market, rather than a bear market rally started seven weeks ago, then it would have started after the second steepest fall in stock prices in the preceding four weeks. Only the 1987 crash was deeper. (The bear market rallies in the 2000-2003 period and current bear market are plotted in red on the chart).
Moreover, these bottoms are also characterised by relatively modest progress in the first five weeks of the bull market, with all bar three of the bull markets registering gains of less than 15 per cent in their first five weeks. It's therefore worth noting that the S&P 500 had risen by a thumping 29 per cent in the five week period between 6 March and Easter. By contrast progress in 1987 was far more sedate in the first five weeks of the new bull market with the market rising a few percentage points. And even in 1970, 1974 and 1998, when the index had slumped by more than 10 per cent in the month leading up to the low, the rise in the market in the first five weeks of the bull market was conservative - less than 10 per cent in all three years.
The conclusion from this data is that either the recent market rally is an outlier in almost seven decades of bull markets or, as seems more likely, it is another bear market rally. This is given credence when you consider that the strength of bear market rallies is generally in proportion to the previous decline. So having seen share prices slump by 30 per cent since the start of the year to very oversold levels, then it would be reasonable to expect an equally dramatic bounce back to unwind this position which is exactly what has happened in the past seven weeks. Moreover, although some bull markets do explode dramatically out of the starting blocks – for instance in 1982 and the last bull run in 2003 – they have one thing in common: the preceding decline in the final four weeks of the bear market was always less than 10 per cent. At the very least this raises serious doubts that the 6 March lows were the final bear market lows.
Volume and Investor Participation
Trading volume is the fuel that drives markets and underpins the sustainability of gains. Bearing this in mind, Mr Hester analysed both the trading volumes on the New York Stock Exchange in the first five weeks of those 19 bull markets and the price performance of the S&P 500 (In chart two, bull markets are denoted in blue and bear market rallies are denoted in red).
It can be clearly seen from the chart that in the majority of the bull markets trading volumes picked up very strongly once the bear market low was in place. In fact, volumes only contracted on four occasions at the start of the bull market – 1957, 1962, 1970 and 1987. However, those four bull markets had one thing in common: contracting trading volumes were accompanied by a modest rise of less than 10 per cent in the S&P 500 in first five weeks of the new bull market. By contrast all the rallies in the past two bear markets have been characterised by below average trading volumes and, in the 2007-2009 bear market, by sharp share price gains.
So if the final bear market low in equity markets was seven weeks ago, it would be the first time in history that both trading volumes have contracted and the S&P 500 has gained more than 10 per cent in the first five weeks of a bull market. True, bull markets, as in 1982 and 1971, can produce stellar gains in their first 25 trading days, but this has always been accompanied by strong trading volumes which has not been the case in the recent rally.
The Anatomy of The Bear
Russell Napier, the author of the excellent book, Anatomy of the Bear, discovered that the end of bear markets are characterised by a final slump in share prices on low trading volumes (as investor selling becomes completely exhausted) and confirmation of the bull market is then signalled by rising prices on expanding volumes. Unfortunately, this has not been the case at the 6 March lows, with daily trading volumes high in the weeks leading up to those lows, and options expiry day on Friday 19 March aside, volumes have been modest during the rally (see chart three).
In addition, Mr Napier notes that even if the start of a bull market lacks widespread investor participation, what counts most is that volume picks up after a new higher level has been established as 'the market should begin to attract buying interest.' In each of the major bear market bottoms, volumes have expanded after the initial rally. Mr Hester's research has found this to be the case having analysed the performance of the S&P 500 during the first six months of a new bull market and the volumes traded during this time (chart four).
What is striking in the chart is that in past bull markets the stronger the rally, the higher the trading volumes. This is illustrated by the upward sloping line in the graph. To put the current rally into perspective, the S&P 500 has already risen 31 per cent from its March lows in just seven weeks. That's not only a greater gain than 18 of the last 19 bull markets achieved in their first six months, but trading volumes to date have been contracting and not expanding. Only the 1998 bull market achieved an explosive rally on contracting volumes, but the current seven week rally has already massively outperformed what the 1998 bull run achieved in six months.
That in itself raises a conundrum as volumes would have to expand significantly over the next four months – during the seasonally weak summer months – for six month trading volumes to catch up to the levels that have characterised past explosive bull markets such as 1982 and 1974. But as the S&P 500 has already surged 31 per cent from its 6 March low to 17 April high, the consequence of a pick up in trading volumes from this point (as buying activity picks up), is that the current rally would become the greatest start to a bull market of all time even surpassing the record breaking performance at the start of the 1982 bull market.
Conclusion
For the S&P 500 to surpass the record breaking performance at the start of the 1982 bull market would seem highly improbable by any stretch of the imagination. Remember the recession – both in the Eurozone and US – is set to be one of the severest we have seen in the past 70 years; the housing slump is deeper; consumer, corporate and government borrowing is far higher (the latter as a percentage of GDP); the fall-out from the financial crisis has some way to run; and the S&P 500 was trading on an earnings multiple over 50 per cent higher at its March low compared with its 1982 low (based on Robert Shiller's adjusted earnings multiple). Faced by these headwinds, and given the warning signals from seven decades of bull market history, far more probable is that another leg of the bear market will unfold in the coming weeks.
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