- The first stage of a bear market usually consists of a very sharp selloff, as investors simultaneously realize that things have turned very sour.
- The second stage of a bear market is an equally sharp, countertrend rally as stocks snap back from oversold lows to recover part of the recent loss.
- Stage three of a bear market is when stocks resume a slower, more grinding downtrend as investors slowly accept the fact that conditions have definitively changed. This stage is beginning.
Stocks Entering Stage 3 of a Bear Market
The first stage of a bear market usually consists of a very sharp selloff, as investors simultaneously realize that things have turned very sour, which results in a rush for the exits and a rapid drop in prices. We saw this occur from February 24 to March 23, when the S&P 500 lost -34% in about four weeks – the most rapid selloff of this magnitude in history.
The second stage of a bear market is an equally sharp, countertrend rally that sends stocks back higher from oversold lows to recover part of the recent loss. After the selloff, bullish investors and day-traders come back into the market to cause a short-term surge in prices higher. This rapid gain makes many investors think that the fundamental economic problems will be solved immediately, and the selloff was just a short-term correction. As usual, many pile into stocks at the end of this bear-market rally, only to lose their shirts as the market enters stage three.
Stage three of a bear market is when stocks resume a slower, more grinding downtrend as investors slowly accept the fact that conditions have definitively changed, and the buy-the-dip mentality that worked for so long is now a losing game. This pattern defines the stage that stocks enter this week, with the S&P 500 has reached a point of substantial resistance.
As shown in Chart 1 below, the S&P 500 SPDR ETF (SPY) bounced from the March 23 low to gain about 34%. The ETF is now running up against its 200-day exponential moving average, which coincides with the 61.8% Fibonacci line at the same level. These are two potent resistance forces that won't be very easy for the index to break. Not impossible – just extremely difficult. Also, after the robust, rapid gain off the March lows, stocks are overbought and due for a decline.
The lower window of Chart 1 above shows the S&P 500 ETF (SPY) Relative Strength Index (RSI), which is now staying in the Bearish range. RSI tends to stay in a range of 40-80 and bull-market conditions and a range of 20-60 in bear-market conditions. It appears that the latter is applicable at this time, and RSI is about to turn down to remain in the Bearish range as stocks resume their decline.
With GDP now predicted to be cut by a phenomenal -30% in the second quarter, the secular economic impacts of the Coronavirus pandemic will continue to pile up, and the value of equities will decline over the coming months (if not years). Stocks are in a secular bear market...
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