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Correction or Bear Market

A correction occurs when a popular stock index, such as the S&P 500 Index (SPX) or Dow Jones Industrial Average (INDU), has fallen more than 10% but less than 20% from its recent high. A bear market occurs when a market declines 20% or more. Most corrections serve two purposes - to alleviate an overbought condition and return to its longer-term equilibrium level or historical fair value.


It is difficult to determine whether a correction will reverse and resume its primary uptrend or turn into a bear market until after the fact. However, most corrections revert to their primary uptrends and do not slip into bear markets. Based on the two dozen market corrections in the past 50 years, only a few transition directly into outright bear markets. The corrections that led to bear markets included 1973-1974, 1980-1982, 1987, 2000-2002, 2007-2009, and 2020.


Investors must remember bull markets do not persist forever. They will end, followed by the next bear market. The repeating cycles from bull to bear and bear to bull will occur many times within an investor’s lifetime. The alternating cycles help correct the excesses (overvaluation) and shortfalls (undervaluation) in the marketplace.


Since the 1920s, the SPX Index experienced ten (10) US bear markets. Three (3) bear markets occurred without the US economy slipping into recessions (i.e., the late-1940s, early-1960s, and Oct 1987 Crash). However, five (5) bear markets led to US recessions (the late-1960s, early-1970s, 1980-1982 Double Dip Recession, 2000-2002 Tech/Telecom Dotcom Crash, and the recent Feb-Mar 2020 Pandemic). Two (2) were extreme bears associated with the financial/credit crisis (1929-1932 Great Depression/Stock Market Crash and 2007-2009 Global Financial Crisis).


The 2/19/20-3/23/20 Covid-19 Pandemic bear decline (-35.41%) was an exogenous shock (i.e., pandemic) that led to a recession. Although it was brief (less than 2-months), it fulfilled the criteria of previous US recession-induced bears (-36.1% to 50.5%).


Is the current Jan-Mar 2022 correction of 14.61% another deep correction within the context of the 2013-present structural bull? Or will it lead to another US recession and the next bear market?


After recording two occurrences of positive outside months on Oct 2021 and Dec 2021, totaling six (6) positive outside months in the past three years, SPX succumbed to its fifth negative-outside month in Jan 2022.


Is the Jan 2022 negative signaling a peak in the decade-old structural bull trend or another deep correction?


One of the prevalent differences today, as compared to the previous negative outside month timeframes, is the extensive spread (724.27 points) between the 10-month ma (currently at 4,481) and 30-mo ma (3,757). Historically, this warns of a widely overbought or overvalued market that needs to reset. Another interesting point is the 2020-2022 rally quickly exceeded a significant SPX price projection at 4,595, based on the Aug 2020 V-pattern breakout. Also, the rally to the record high of 4,818.62 (1/4/22) failed to surpass the top of the pivotal 2009 uptrend channel (green dash line now trading at 4,840).


We recommend investors and traders closely monitor the 10-month ma (4,481), as failure to convincingly surge above the key moving average, preferably by the end of the month, warns of a retest of the 30-month ma (red-dash line at 3,757). Further note, the internal trendline (blue dash line) is currently rising near 3,733, providing additional support. A breakdown further solidifies the next bear market, opening the door for a decline to 3,195-3,233 (61.8% retracement from Mar 2020-Jan 2022 rally and the 38.2% retracement from 2009-2022 rally), and below this to 2,714 (bottom of the 2009 uptrend channel).


Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

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