The stock market may have staged a remarkable turnaround and be trading near record levels, but the bears know that the underlying fundamentals are very weak. While there is no single indicator that proves a bear market is on the way, there is a raft of data that, taken together, suggests we are already in one. That said, there are numerous ways for investors to profit during a bear market.
Markets Bearish Despite S&P 500 Being Near Record Levels
The S&P 500 may still be trading near record levels, but stock market bears know that it’s not because of strong earnings and revenue growth. Stocks are being supported by the Federal Reserve’s artificially low interest rates and aggressive corporate share repurchase programs. If investors took these two indicators out of the equation and took a long, hard look at the shape of the U.S and global economy, more would fall on the side of the bears.
Case in point, the S&P 500 is only as strong as the stocks that make up the index. And those stocks are not doing well. In fact, we’re in the midst of an earnings recession. The first quarter blended earnings decline for S&P 500 companies was -7.1%. This is the first time the S&P 500 has reported four consecutive quarters of year-over-year declines in earnings since 2008.1
While analysts expect earnings growth to return in the second half of 2016, they said the same thing last year. S&P 500 companies are reporting disappointing results because the U.S. and global economies remain fragile. And the earnings recession does not look like it’s going to reverse anytime soon.
Bear Market Getting Warmed Up
Again, the S&P 500 may be trading near record levels, but it’s important to note that doesn’t mean the bull market is alive and well. Quite the opposite—the S&P 500 hasn’t reached a new record high since May 2015. It’s in correction mode.
Outside of the current “bull” market, only one other bull market since 1900 has experienced a correction that has lasted longer than one year. On average, a correction within a bull market typically lasts around five months. The longest bull market correction (1990s) lasted 379 days.
Unless the S&P 500 surges miraculously to record levels, for seemingly no reason, in the next week, the 1990s bull market correction will be surpassed by the current one. It’s pretty tough to say the bull market is alive when it’s acting anything but.
Earnings are down and the outlook is bleak. First-quarter GDP was just 0.5%.2 Stocks need a reason to climb higher. And there isn’t one. There is a good reason, though, for stocks to go through a serious correction.
Because of artificially low interest rates, investors have been pouring cash into stocks; there is nowhere else for them to make money. Regardless of what earnings have been, stocks have been climbing higher and higher.
According to the Case Shiller P/E Ratio, the S&P 500 is overvalued by 63%. The ratio is currently at 26.11 (the 10-year average is 16.66). That means that for every $1.00 in earnings a company on the S&P 500 makes, investors are willing to pay $26.11. The ratio has only been higher three times before, in 1929, 2000, and 2007. All three instances were followed by a collapse.3
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Bull and bear markets are part of the cyclical nature of the stock market. Every time there has been a major correction or bear market, the stock market has rebounded. That doesn’t mean the only way for investors to profit is during a bull market.
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- “Key Metrics,” FactSet web site, May 13, 2016; https://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_5.13.16.
- “National Income and Product Accounts Gross Domestic Product: First Quarter 2016 (Advance Estimate),” Bureau of Economic Analysis web site, April 28, 2016; https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.
- “U.S. Stock Markets 1871-Present and CAPE Ratio,” Yale University web site, May 25, 2016; https://www.econ.yale.edu/~shiller/data.htm.