On Friday my market risk indicator cleared its warning. Does that mean the bear market is over? I doubt it. I’ll show you why in several charts below, but lets start with a longer view of market risk indicator warnings. Take a look at the chart below and you’ll see that the indicator is prone to whipsaws. As I’ve mentioned many times before, the indicator generally warns at inflection points — right before the market resumes its uptrend or accelerates to the downside. It also often clears just as the market is peaking. Especially, when the market is entering a more volatile phase like late 2007 thru early 2008, then again in the summer of 2011. I suspect that’s what we’re seeing now… but because I can’t see the future I set my bias aside and follow the signals. Who knows, this recent signal could be followed by a huge rally like the cleared warning in 2012. Long story even longer, the indicator has a lot of whipsaws, but the money made by hedging with volatility on the steep declines makes up for the losses (or under performance) during the whipsaw signals.
Next, let’s look at Dow Theory. It signaled a long term bear market was underway on 2/11/16, then promptly started a steep rally. This is consistent with past Dow Theory performance at the start of bear markets. The current rally has both retraced enough of the previous decline and lasted long enough to consider the last lows as new secondary lows. That means the current rally could retrace up to 66% of the previous decline and last up to three months. We’ll still be in a Dow Theory bear market until the last secondary highs are reclaimed.
As a side note, strong rallies like the one we’re in is why you should never use Dow Theory signals as “buy” or “sell” signals. There is no such thing as a Dow Theory buy or sell signal. Dow Theory signals inform you of the long term trend, which at the moment is down. As a result, the signals should tell you whether you should be buying dips or selling rallies.
The monthly chart of MACD for the S&P 500 Index (SPX) shows no sign of wanting to turn back up. Momentum has ticked up, but that is normal behavior during bear markets.
Weekly MACD for SPX is still deep in negative territory. RSI has recovered, but generally turns down below 55 in bear markets. Watch for RSI to turn down on a weekly basis as one of the first signs the downtrend has resumed.
When I put it all together, I have to conclude we’re still in a bear market. I’d like to see monthly MACD turn back up and Dow Theory change to a bullish trend before calling the bear dead. The core portfolios have a large hedge which will soften the blow if the market turns back down. The volatility hedge is much more aggressive being 100% long and will likely suffer a larger draw down before hitting the “big one” and making up for all of the whipsaws. As always, let your own risk tolerance be your guide on how and when to protect your portfolio.