Behind the Money

Bear Market Isn't Over Yet Despite This Week's Rally

Bear markets rarely end once stocks have fallen 20 percent—the traditional definition on Wall Street—and this one won't be any different, traders and analysts believe.

At its intraday low this past Tuesday, the S&P 500 was off 21.6 percent from its May 2 high, marking the 16th "official" bear market since 1940.

But before Tuesday's close, stocks rallied back above the 20 percent threshold on hopes that Euro-zone officials are hatching a bigger and broader bailout plan.

After that day’s four-percent reversal, the equity benchmark continued to rocket higher the next two days and ended the week about 16 percent below the May high. But investors shouldn't presume that the dance with the bear is over.

Tuesday’s “pattern did not meet the explosion in volume that typically comes with a climactic capitulation,” said Mary Ann Bartels, Bank of America Merrill Lynch technical analyst, in a note. “Once a bottom is formed it generally takes several months to complete a bottoming process.”

This bottoming process could involve a further 10 to 12 percent decline with heavier volume, Bartels said. History shows she might be correct.

Over the last 70 years, bear markets have averaged a 32 percent decline (and a median 28.8 percent drop), according to analysis of data compiled by Bespoke Investment Group.

The deepest bear market ended in Nov. 2008 following the collapse of Lehman Brothers, with more than half of the equity market’s value wiped out from the 2007 top.

However, the equity losses credited to the housing crisis were even deeper if you ignore a slight 47-day respite at the end of that year when the benchmark snapped back by 24 percent (technically a bull market). It continued to lose more than another 20 percent before finally bottoming out in May 2009 at the ominous intraday level of 666.76.

The S&P 500 this month is in the process of forming a trademark “head and shoulders” pattern, according to Abigail Doolittle of Peak Theories Research. Currently, this bear market is forming the right sight of the “head” portion of this pattern.

“In fact, the head and shoulders pattern’s next "call" is for a move down in the S&P to some level between about 1011 and probably 1040 and to its neckline,” wrote Doolittle in a note to clients. “Such a potential drop would represent a roughly 10 to 15 percent plunge from current levels in the weeks ahead and presumably on continued fears around the euro-zone debt crisis and weak economic data here in the US.”

If this bear market sticks, the U.S. will find itself in good company. The majority of major markets in the world are in bear territory. At last count, 20 of the 29 major world markets—from Italy to China to even Colombia—were in bear market territory, according to Birinyi Associates.

“This is a Lehman situation in Europe,” said Stephen Weiss of Short Hills Capital, who believes our dance with the bear is not over. “Europe is already in recession and China and U.S. will soon be there.”

To be sure, some investors believe we are near that emotional point that occurs near the end of bear markets when sentiment gets so negative, that there is nearly no one left to keep selling and therefore a rebound must ensue. As referred to by Bank of America’s Bartels, this capitulation typically occurs with a few down days or strong reversal days on very high volume.

The large selling to end the month of September “felt rather surreal to me, as much of the economic data and comments from companies have been rather benign,” wrote Jim O’Neill, chairman of Goldman Sachs Asset Management and a long-time global analyst who coined the term ‘BRIC’ to describe the major emerging markets. “And yet, markets continued to explore the grimmer angles.”

What was the title of O’Neill’s report to Goldman’s clients? “Let’s Worry About Everything.”

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