A Bear Market Rally or a Deep Correction?
Investors continue to focus on headline news. Bullish and bearish convictions are shifting on a daily and weekly basis. While stocks have recovered from their earlier losses, SPX Index has generated a death cross sell signal as the 50-day ma has crossed below the 200-day ma. Many S&P 500 stocks and S&P 500 sectors have fallen more than 20% this year, placing them in bear market territories.
As the correction from early January continues, SPX has experienced several explosive rallies and sharp drops. Neither the bulls nor the bears can take control as the market churns within a wide range between 4,100 and 4,800. Despite the increase in market volatility as the result of soaring commodity prices and surging inflation, continued uncertainties surrounding Russia’s invasion of Ukraine, and economic concerns about a global recession due to the potential for a policy mistake from the Fed and central bankers, the SPX Index remains in a structural/secular bull market. Nonetheless, we expect investors will continue to debate whether the current market action is a bear market or a deep correction within a bull market.
As the name implies, a bear market rally is a short-term move that develops in a bear market. A bear market is when a market has fallen by 20% or more. The bear market rally tends to be enticing for buyers as it can appreciate from 10% to 20% plus. The main difference between a bear market and a bull market rally is the duration. The former is temporary, and the latter is sustainable. A bear market rally starts with an abrupt reversal from a low, often unexpected, but it cannot sustain and follow through to new highs.
In many cases, investors have no idea if the rally can sustain, making a bear market rally extremely challenging. Attempting to catch the start of a bear market rally is often fraught with risk as traders will not be able to enter near the low and exit near the top. At times traders can generate sharp gains. The majority of the time, they will suffer significant losses. Trading within a bear market rally is challenging because you are trading against a primary downtrend, akin to a swimmer fighting an incoming tide. The counter-trend trading is more suitable for disciplined traders who can take high risks and realize short-term profits and losses.
What is a bear market rally?
Most bear market rallies will often have the following traits:
(1) The market declines 20% from the high to a low before forming a near-term bottom.
(2) The bottoming process will take a couple of months or more to develop.
(3) Volume should expand or is higher than average, emerging from a pivotal market low.
(4) A technical reversal pattern is evident before the start of the bear market rally.
(5) The bear market rally tends to be explosive and can move quickly in a short time.
(6) A typical bear market rally can result in a move of 10-20% or more but will stall and reverse direction as the primary bear market returns.
(7) A lower-high tends to form once the bear market stalls. A violation of the previous bottom sets up another lower-low pattern, reinforcing the bear market.
Is the recent S&P 500 Index rally a bear market rally or a correction within a bull market?
The rally from 3/14/22 low (4,161.72) is nearing a critical phase. The outcome of the impending battle between the bulls and the bears will help decide if this is a bear market rally and the resumption of the bear market trend or a deep correction within a structural bull trend.
The SPX Index may not be a bear market rally since the longer-term trend remains in an uptrend. Also, based on the concept that bear markets should decline 20% or more from the high, the recent 1/4/22-2/24/22 pullback is only a 14.61% decline. So, is this then a deep correction within a primary bull market?
Technically speaking, there are mixed signals. The current 8-day rally of 360.28-points may be sharp and explosive, but with gains at 8.66%, it falls just short of the 10% to 20% rallies typical of bear market rallies.
The steepness of the current rally and the expansion in volume from the March bottom hints at short-covering, which often occurs during bear market rallies. However, a flag/pennant pattern has also developed into the recent rally. Most flag/pennant formations are continuation patterns within an existing uptrend. The height of the flag/pennant is 360.28-points. A breakout above the top of the flag at 4,522 renders an SPX projection at 4,882. If this occurs, the SPX surpass the 1/4/22 all-time high (4,818/62), establishing a higher-high pattern and reaffirming the bull market.
A classic sign of a bear market rally is a series of lower-highs and lower-lows, defining a downtrend. The ability of SPX to clear above 4,595 or the 2/2/22 high negates a lower-high pattern and the right shoulders to a head/shoulders top. Accomplishing this feat is critical as it reaffirms the recent Jan 2022 downtrend breakout as a key reversal.
Another interesting point worth mentioning is a classic bear market rally tends to fade near pivotal resistance, coinciding with the 61.8% retracement (4,549.70) from 1/4/22-2/24/22 decline. A breakout above the 61.8% retracement (4,550) hints of the next rally toward 100% or the 1/4/22 reaction high at 4,818.62. Above this would reaffirm the continuation of the bull market, leading to the next significant SPX rally.
The SPX Index will likely remain choppy and challenging over the near term, at least until the next FOMC meeting in early May 2022 and the release of the corporate earnings that begins in a few weeks.
The SPX is nearing critical resistance at 4,550-4,595. Failure confirms a bear market rally, triggering a sharp downturn that leads to a cyclical bear decline. Intermediate-term SPX support remains near 3,500-3,800. The action could confirm a deep correction within the existing structural bull market. Above 4,595 will likely trigger a massive short-squeeze and force money managers sitting on the sideline to return, leading to another all-time high and reinforcing the structural bull market.
We recommend investors and traders pay attention to the market actions heading into next week, coinciding with the end of the month and the end of the first quarter.