Being in US stock markets last week felt like riding on a roller coaster. At the beginning of the week, stocks fell again and fell hard. The S&P was down another 5% or so on Monday. Then on Tuesday it began to bounce, a bounce that would very much be normal and expected when stocks were so deeply oversold—on the daily charts—on Monday. The bounce continued for the remainder of the week, and the S&P500 actually finished up on the week….rising by about 0.9%.
Volume, as one can imagine when stocks were initially down about 5%, exploded to the upside. More impressively, volatility also exploded higher. The VIX index surged above 50 on Monday, a level last seen only in the 2008-2009 meltdown. But then, as prices bounced for the rest of the week, volatility dropped but nowhere near the super low levels of the summer. By Friday, the VIX retreated only to the upper 20’s, which meant that traders were still very nervous despite the big bounce in prices.
The big new for the S&P500 is the technically important “Death Cross”. Most bear markets (defined as a drop from peak of at least 20%) don’t happen unless the Death Cross occurs. What is it? It’s when the 50 day moving average of the S&P crosses below the 200 day moving average. And it hasn’t happened to the S&P since mid-2011 when the S&P did actually retreat by about 20%. Back then, on the back of the various QE programs initiated by the Federal Reserve, the S&P recovered fairly quickly after initially dropping about 20%. And not only were all the losses recovered, but the S&P went on to hit new highs for the next three and a half years, until finally cracking earlier this year.
So does this mean that we should prepare for a certain 20% drop in the S&P? While the drop so far was only 10% (intra-day and quickly erased by the end of the week), the probability of a 20% total drop has gone up. That said, it is by no means certain to happen. There have been times in the past when markets have recovered from an initial Death Cross.
Still, all bear markets are preceded by a Death Cross, and while not always, most Death Crosses are followed by 20+% total losses.
At the very least, this is another serious warning sign that the 3+ year old bull market run is nearing an end. And that if investors are not prepared to ride out some major price swings over the next several months, then now—after a nice bounce—may be a good time to pull back exposure to US large cap stocks.