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How Bear Markets End

It is significant that just about anyone can spot a bear market after it has happened, but few have a methodology for defining what a bear market is, when it has begun, and when it has ended. Given the duration and severity of the declines in the current bear market, it is appropriate to analyze methodologies to determine when the bear market has ended and a new bull market has begun. You can find some of my material on the subject of bear market completions at Stockbee.blogspot.com – just do a search for my name in the ‘Search Blog’ field.

A successful methodology must simply catch the long-term shift from primary selling to primary buying by market participants. Because historic average volatility remained much lower than current levels for many years, the old definition of the start of a new bull market, any increase of 20% or more in a market, is not appropriate in the current high-volatility environment. Under the old definition, there have been three new bull markets since last October – clearly another methodology must be used in order to be useful in the real world.

So what is a good indication that the pendulum of the market has swung from down to up? First we must define the timeframe of the trend on which we wish to focus. Are we talking about a daily timeframe? Weekly? Yearly? To talk of trends at all is without meaning unless a timeframe is specified. We will focus here on the long-term timeframe, which covers the one- to two-year period. In analyzing the major bear markets since 1929 – the 1929-1932 Great Depression bear market, the 1973-1974 Vietnam War/Watergate bear market, and the 2000-2002 Tech Bubble Bursting bear market – several key factors have defined the end of long-term bear markets.

The first element is the market trading above a long-term moving average: the 200-day moving average. There is nothing inherently magical about the 200 DMA, but it does represent the average price of a relatively long timeframe (about 10 months of trading), and has proven to be a reliable tool in defining whether the market is trending up, down, or sideways. When using the 200 DMA, two things are important: the market price relative to the 200 DMA, and the slope of the 200 DMA. The market may break above the 200 DMA and remain above the moving average for days, or even weeks, as happened from August-October 1932, October 1973, and March 2002, while not changing the downward direction of the long-term bear market. However, once the slope of the 200 DMA has turned up and the market has crossed above the 200 DMA, each time, among the bear markets mentioned, the market has seen subsequent significant gains over the following months and years, and the bear market lows were not breached thereafter*.

The second element to define the end of a bear market is the ability of the market to breach the high point of the previous significant rally. This can only be accomplished when there is greater pressure from buyers versus sellers in a sustained trend. Clearing a prior high also means that everyone who bought and held since the prior high has made money – this tends to give market participants more confidence, so they continue to allocate more money to the market, thus reinforcing the new uptrend. Until the market successfully breaches a prior high, there is no way to know if the upward momentum is likely to continue, as the market’s strength has not yet been tested. Therefore, a new bull market, by definition, cannot take place without the market first trading above a prior rally high.

So, armed with this knowledge of bear markets, where does the current market stand in the long-term trend? Well, the S&P500 cleared the 200 DMA on June 1st by a margin of several percent, but the 200 DMA remains in a downward slope – strike one. In June, the S&P500 also tested its prior rally high made in January. However, after failing to close above the January high by more than a couple of points, the index then dropped 9% over the next few weeks – strike two. No new bull market there.

And how about the NASDAQ? In late-April, the NASDAQ breached its prior rally high made in January, and has remained well above the prior high ever since – first test passed with flying colors. In late-May it then breached its 200 DMA and has also remained well above the moving average ever since. However, the slope of its 200 DMA, like that of the S&P, is still pointing down – the bull market has not yet been confirmed.

So the US equity markets remain in long-term bear trends. Although the groundwork has been laid for the next bull market, it will likely take at least several months before a successful attempt at breaking the bear trend will occur. Currently at 883, even if the S&P500 stays in a range between 850-1000 for the next two months, the 200 DMA will only begin sloping up sometime in September at the earliest. Therefore, although it has had a run for its money, the bear market remains alive and is likely to remain the primary long-term trend for the foreseeable future.

*The 2002 lows were in fact breached in the current bear market, but not before the market rallied 70% after the 200 DMA began sloping upward.