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Time Tested Clues that Detect a Major Stock Market Downturn is Near
Every single past generation has gone through serious multi-year stock bear markets where the financial devastation was well remembered with fear & anger.
Since many of these horrible market corrections were induced by out of control inflation, the time seems right to discuss what to look for and to act before the damage is done.
The Grim Statistics
These five stock bear markets (1906-07, 1929-32, 1939-41, 1973-74, 2000-02) averaged two years in duration where losses exceeded -40%. Their average annual decline was -15%, and it took nearly 10 years on average to return to the market’s previous high. The four-year decline of the Great Depression was the worst to date, with a cumulative decline of -63%.
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Early Warning Detection of Significant Market Declines
Sorry, there is no magic indicator to consistently pick a top of a bull market!
However, there are tools that investors can use to gauge the health of the stock market similarly to how doctors use various tests during physical exams on their patients. Experienced investors know how to properly use a series of indicators to gain a consensus as to the market’s overall strength and to take defensive action early in a downtrend to protect profits.
Although many tools are used in stock market analysis, the 40-week moving average of major stock market indices combined with the NYSE Advance Decline Line (AD Line) worked well in timing these five mega bear markets (see charts):
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· Moving averages are used to determine market direction, and the 40-week time frame proving to be very effective for long term trends. If an index price is above the moving average, then the index is in an uptrend. If the index is below the moving average, then the index is in a downtrend.
· An Advance Decline Line measures the number of individual stocks where prices are moving up versus down (unweighted). A 40-week moving average is also effective with this statistic to determine internal market strength.
Impressive Results
As can be seen in the charts, the internal strength of the market erodes for many months before a new high was made in the index itself. For example, the NYSE AD Line had started to decline many months before the S&P 500 Index crossed below the 40-week moving average, thus beginning a new bear market.
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Watch January For Clues
There is an old saying, “As January goes, so goes the year”. Since 1970, there have been 20 times when the DJIA & S&P 500 Index both had negative results in January. As expected, the average inter-year correction during those years was -18% and the year usually finished at a loss.
We are overdue for a market correction. It could be the making of the perfect financial storm if all three of these time-tested indicators turn negative with U.S. stocks are at record valuations.
Keep in mind that multi-year bear markets spare no stock from the carnage. Its best to forget about diversification as protection and to re-allocate your portfolio to significant cash holdings or use hedging tools to protect your portfolio’s value and hang on to the previous bull markets hard fought gains.
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Remember the old saying, “Buy Low, Sell High”!
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