The Bear Market In Stocks Is Probably Over

The 2022 Bear Market In Stocks Is Probably Over

It’s only been a month but already markets are looking a lot different than they did last year.

So far this year, the S&P 500 is up 6%, the Nasdaq 100 (tech) is up 11%, and the Russell 2000 (small caps) is up 7.3%. It’s an even better showing outside the US, with developed international stocks up 8% and emerging market stocks up 12%.

But after several failed rallies in 2022, is this just another bear market rally that’s destined to be sold and unwind to new lows?

Based on the constant barrage of negative headlines (“imminent” recession, inflation still too high, expected earnings decline, upcoming debt ceiling fight etc.), I think many investors are saying yes.

Or, can the recent strength in the stock market be sustained long enough to power a breakout that marks the start of a new cyclical uptrend and the continuation of the secular bull market that began in 2013?

I don’t know. But I think so. Here’s why in 5 charts.

1. Volatility Breakdown

Investors have been conditioned to expect a big risk-off event like COVID in 2020 or the Great Recession in 2008/2009 to mark the end of the bear market that started in January 2022.

That’s why for all of last year, many investors weren’t anticipating a bottom in stocks until they saw a big capitulation event that would send the VIX soaring above its sideways range.

What’s the VIX? The VIX — or volatility index and “Wall Street’s fear gauge” — helps measure volatility in stocks. Typically, when the VIX moves higher, stocks move lower (and vice versa).

Well, so far, that event hasn’t materialized. Instead, we just saw stock market volatility breakdown to its lowest level in a year.

Bear markets don’t always need a big risk-off event to mark the bottom. Instead, an orderly death by a thousand cuts could be the playbook for stocks until a recovery gets underway.

2. Junk Bonds Are Outperforming Treasuries

Risk-on junk bonds have been outperforming risk-off Treasuries of similar duration since the end of June. That’s not something you’d expect to see heading into “the most anticipated recession ever.” While the ratio has yet to break out to new highs, it’s pretty darn close.

Note: The ratio chart above compares the relative performance of risky corporate junk bonds against safe US Treasury bonds. When the line moves down, like it did in March 2020, it shows safe bonds are performing better than risky bonds. When uncertainty is high, investors flock to safety. Right now, the exact opposite is happening. If this trend continues, it should be supportive for stocks.

3. The Median US Stock Has Gone Nowhere For 25 years

I know that’s a bold statement to make given how well the S&P 500 has performed over the past 25 years (+547%).

But remember, there are more than 5,000 stocks listed on the Nasdaq Exchange and New York Stock Exchange. And over any given time period, just a handful of companies can drive the bulk of market returns.

That’s why I track the Value Line Geometric Index, which was built to measure the price movement of the median US stock.

The index has been consolidating sideways for the past two-and-a-half decades, and in September it successfully tested its former resistance going back to 1998, 2007, and 2015 as support. A key rule in technical analysis is that old resistance becomes new support in uptrends. A follow-through move to the upside could bode well for the broader stock market.

4. Sentiment: Why So Bearish?

The ongoing bearish sentiment towards stocks has set records, according to the weekly AAII Investor Sentiment Survey. The survey asks respondents the simple question: Will the stock market be higher or lower in the next six months?

Bearish respondents to the survey have outweighed bullish respondents for 57 of the past 58 weeks. The consistent level of pessimism is unprecedented going back to the survey’s start in 1987. People really don’t like stocks right now.

That level of skepticism is the exact type of fuel the market needs to continue its recent strength, as each incremental advance higher wins over a new group of bearish investors.

And there’s a lot of fuel.

At the end of the third quarter, there was a record $1.3 trillion sitting in retail money market funds. Altogether, across both investors and institutions, there’s a record $4.8 trillion sitting in money market funds.

My favorite encapsulation of the current investor sentiment is the chart below from Goldman Sachs, which measures individual stock trading activity among retail investors.

The chart shows that retail investors have sold all of the individual stocks they bought from 2019 to 2021 (excludes ETFs/Mutual Funds). From a contrarian perspective, this is a good sign for markets (go against the herd). It also means a lot of the unsustainable froth/speculation has been unwound, which is healthy for markets.

5. Seasonal Tailwinds

Human behavior doesn’t change, especially when it comes to the decisions they make in the stock market. That’s why I find seasonal data so fascinating.

The market has a lot going for it right now based on the historical data.

1. A positive S&P 500 return in the first 5 trading days of the year: Check

2. Gridlock in Washington D.C. via split control of Congress: Check

3. Entering the best performing year of the 4-year Presidential cycle: Check

4. The S&P 500 is poised to finish January with positive returns: Check

Each of the four criteria has historically preceded strong market returns for the rest of the year, on average, based on decades of historical market data.

That’s why there’s an old Wall Street adage (in relation to #4): “so goes January, so goes the rest of the year.”

One thing is for sure, the S&P 500 has a lot of work to do to recover last year’s losses, and it’s not going to be easy. Below are some of the key resistance levels I’ll be watching.

Investing is Hard!

Like, really hard. It’s incredibly difficult to see your hard-earned money fluctuate up and down day-to-day, influenced by factors that are outside of your control.

This is why the average investor has done worse than the broader stock market over the past decade. Even worse than a portfolio of 60% stocks and 40% bonds.

One strategy to take advantage of this disconnect between what the stock market does and how the average investor’s portfolio performs is to get enrolled in a dollar cost averaging plan.

Contributing small amounts of money to your investment account on a scheduled basis (monthly, bi-weekly, weekly etc.) helps you catch both the ups and downs of the stock market and keep your emotions at bay.

🙏 Thank You For Reading!

I’m here to help you navigate this process. Have any questions? Please reach out!

You can call (607) 882-1434, or e-mail me at [email protected].

Did you find this e-mail helpful? If so, chances are you might know someone else who would too. Feel free to forward this e-mail to them.