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Stocks enter final full week of the year on the brink of a bear market

Key Points
  • Stocks are on the verge of a bear market and start the Christmas holiday week, usually a positive one, coming off one of the worst weeks in 10 years.
  • The Nasdaq was the first of the big three indexes to fall into a bear market, a 20 percent decline from highs, but the S&P and Dow are not far behind.
  • Trading activity is expected to be light in the coming week, though sentiment is likely to remain very negative, unusual for a week that is often positive.
A grizzly bear roams through the Hayden Valley in Yellowstone National Park in Wyoming.
Jim Urquhart | Reuters

Stocks head into the final full trading week of the year on the brink of a bear market.

The Dow Jones Industrial Average plummeted in the past week in its worst performance since before the bull market began, in the very thick of the financial crisis in the fall of 2008.

While the market is seemingly oversold, strategists see little chance for any bounce in the week ahead, and the focus will remain on Washington's fight over a government shutdown. Strategists say it may be too soon for investors to look for bargains among the rubble in what has traditionally been one of the quietest weeks of the year.

The Nasdaq Composite Index, dragged down by tech and biotech, was the first index to close in bear market territory, and is now 22 percent from its high. The Nasdaq lost 8.4 percent to 6,332 in the past week.

The Dow fell 6.9 percent in the past week, to 22,445, and is now just 3 percentage points away from bear market territory, or a 20 percent decline. The S&P 500 was down 7 percent for the week and is just 16 points away from a key support level of 2,400. It is also just about 2 percentage points from a bear market.

"Even if we do [get a Santa rally], it's not going to be meaningful. It's going to be super light volume, with a half trading day," said Michael Arone, chief investment strategist at State Street Global Advisors. "Normally, this has been one of the strongest months of the year, but so far things in 2018 that normally have happened haven't been happening."

In a bad sign on Friday, volume was really heavy. More than 12 billion shares changed hands on U.S. exchanges on Friday, the biggest volume in at least two years.

The stock market closes after a half day on Monday, Christmas Eve, and is closed Tuesday.

Dismal December

December's performance is nearly the worst on record for the month, with the Dow's decline of 12 percent the worst since 1931. December is typically a good time of year for stocks, and this December is on track to be the worst month of the year for the first time ever.

"I would imagine trading activity is going to slow down quite a bit," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch. "Overall, I think the focus is going to be on getting things tied up ahead of year's end. It's possible there could be some outsized moves given reduced liquidity. I think there's going to be a lot of focus on getting a fresh start next year."

Technical analysts say the market continues to look weak, with many stocks in bear market territory already and trading well below their 200-day moving averages.

The S&P 500 had been in a range from 2,600 to 2,800 for four months, but quickly fell out of it all the way to 2,400.

"The measured move was reached faster and more furious than most people thought," said Scott Redler of T3Live.com. "It doesn't seem like anyone wants to step in the way of the headlines that are piling up. And why would they? The next level traders would like to see tested is 2,250 to 2,300."

A negative chart formation that emerged last week, known as a head-and-shoulders formation, points to a level of 2,300 in the S&P 500.

"Buyers are just sitting back and instead of playing an oversold bounce, they're just waiting," he said. "Anybody's that tried to position for a Santa rally has been absolutely run over. The calendar issues have been all off."

Government shutdown

Hanging over the market in the week ahead is the government shutdown fight, which pits the president against Democrats in Congress, over his plan for a border wall. There was a glimmer of hope late on Friday that a deal could be hatched, with Sen. Bob Corker saying a path forward was being discussed.

Still, a missed midnight deadline meant a partial shutdown began on Saturday.

While traders said there was not much concern about the partial shutdown, a bigger worry was the fighting that could become the norm once Democrats have control of the House in January.

"It does seem like it's weighing on sentiment. It's more a signal about just how difficult things will ultimately be. It enhances expectations for gridlock in the future," said Cabana.

The Fed this past week was viewed as a major catalyst for the sell-off, after it released a forecast for more rate hikes at the same time it sees a slower growing economy.

That sparked concerns that the Fed was heading for a policy mistake, and comments from Fed Chairman Jerome Powell that the Fed's balance sheet rolldown was on "autopilot" really spooked traders.

But on Friday, New York Fed President John Williams kicked off a brief stock market rally when he told CNBC the Fed is willing to reconsider its policy depending on the economy and conditions. His comment was not unlike Powell's, but traders said he sounded more flexible and sensitive to market conditions.

Strategists point to a few big concerns for the markets heading into next year — the most worrisome being trade and the Fed.

Wilmington Trust chief economist Luke Tilley said his base case is there will be a trade agreement with China that avoids the next round of tariffs.

"The tariffs so far don't have much impact on the economy," he said. "If we moved into 2019 and all tariffs were implemented, that would very quickly outweigh all stimulus we have coming into 2019. That would be a weight on GDP growth and bring our numbers down for next year."

Cabana said growth for the beginning of the year looks good, and if sentiment could stabilize that might help markets. Treasury yields fell in the past week, with the 10-year yield at 2.78 percent Friday.

"We think rates could be higher. We think 3 percent is reasonable ... but quite honestly risks appear quite heavily to the downside," he said. "The bigger ones are international and geopolitical in nature — what happens to trade, China's economy, Brexit, European populism and gridlock in the U.S."

Cabana said the low end of the range for the 10-year yield could be 2.5 percent.

What to Watch

Monday

Christmas Eve holiday

Stock market closes at 1 p.m.

Tuesday

Christmas holiday

Markets closed

Wednesday

9:00 a.m. S&P/Case-Shiller HPI

10:00 a.m. Richmond Fed surveys

Thursday

8:30 a.m. Initial claims

9:00 a.m. FHFA home prices

10:00 a.m. New home sales

10:00 a.m. Consumer confidence

Friday

8:30 a.m. Advance economic indicators

10:00 a.m. Pending home sales