11-19-2018 Market Read

I have been assuming that we are in a bear market since September. It is impossible to know for sure until it happens. The setup is very much like 2007, where the NASDAQ topped on October 31.
In both cases, we had a late-stage bull market. The NYSE Advanced-Deline line diverged from the major indices in both cases. In both cases, we had a large number of Hindenburg Omen signals telling me that a large number of NYSE stocks were making new 52-week lows while the indexes were climbing. This is an alert for me that much of the market is in their own private bear market while the major averages are making new highs.

In 2011 I researched volatility. I looked at every one-day change in NASDAQ prices since 1971. I mapped every 4% or larger (up or down) one-day changes into the following three epochs: Bear Market, Bull Market, Major Correction. I found 92% 4% or larger changes were contained in bear markets. Raise the bar to 6%, and I found 95% were in bear markets. Raise the threshold to 8% and 100% were contained in bear markets. We have had two 4%+ moves in the market since the last high price. This gives me some confidence in my market read. The FAANG leadership is over, an index of FAANG stocks is 27% off the August high.

Leading stocks have broken out. CROX and ULTA are the defacto leaders, but, so far on average, the breakouts are not making money. The short side is making money and has been relatively easy to play. This morning I shorted LRCX, AVGO, GDS, and SHOP.

In 2007 I made the same call as I am now, I was out of my long positions by November 8, 2007, and moved to the short side. We didn't confirm the bear market status until January 2008. In March 2008 we had a nice tradable bear market rally.

So my current market posture is short rallies until a tradeable long setup appears. Timing is important on two time scales when taking short positions. I need to be right about the path of least resistance over weeks to months. Right now I am saying downward. When I initiate a position, I need to be right about the short-term direction also. Bear markets are quite volatile and taking a position in an oversold market is asking to be stopped out, even when you are right about the long-term situation.

Happy trading

Mike Scott
Cloverdale, CA