Bearish Sentiment Mounts But Not Too Extreme
By: Jeffrey A. Hirsch & Christopher Mistal
February 11, 2016
The market battled honorable today but finally lost and reached the official Ned Davis Research defined bear market level. As we helped clarify last month in order for NDR and us (since we have always preferred and subscribed to NDR’s definition) to declare an official bear market DJIA had to close below its August 2015 low. This would put DJIA down, peak to trough, greater than 13.0% after 145 calendar days.
Whatever the bearish case may be, it sure looks grim out there on The Street. Our Almanac Investor portfolios have been trimmed rather substantially over the past month, but at considerably higher prices as we had employed our usual prudent stop loss policy of selling any stock or ETF that closes below our stop loss the following day. Several longer term holdings were stopped out with gains, of course after giving some back, and some recent selections logged losses. 
It is during volatile times like these that keeping emotions in check is paramount. Having a predetermined exit strategy such as our stop loss policy is essential. It is at times like these that we turn to page 191 of the Stock Trader’s Almanac 2016 and reread G. M. Loeb’s “Battle Plan” for Investment Survival. Towards the bottom of the page under the paragraph heading “Closing Out a Commitment,” Loeb’s wisdom is: 
If you have a loss, the solution is automatic, provided you decide what to do at the time you buy. Otherwise, the question divides itself into two parts. Are we in a bull or bear market? Few of us really know until it is too late. For the sake of the record, if you think it is a bear market, just put that consideration first and sell as much as your conviction suggests and your nature allows.

“If you think it is a bull market, or at least a market where some stocks move up,
some mark time, and only a few decline, do not sell unless:
? You see a bear market ahead.
? You see trouble for a particular company in which you own shares.
? Time and circumstances have turned up a new and seemingly far better buy than the issue you like least in your list.
? Your shares stop going up and start going down.”
There is much more on that page so please do yourself a favor and review page 191 and page 192 with Loeb’s Investment Survival Checklist. So the question remains. Are we in a bull or bear market? And if we are in a bear, where is the bottom? In order to help ourselves reach a verdict let’s review market sentiment first, specifically, our two go-to contrary market sentiment indicators: Put/Call and Investors Intelligence Bullish and Bearish Advisors %. 
Sentiment indicators are contrary by nature. Extreme investor and trader negativity is most prevalent at market lows and is bullish, while excessive optimism is seen near tops when the market is running high. But it is the extreme negativity that has been more indicative of major low points and much closer in proximity on the calendar to the actual low point. 
To illustrate we have lined up below charts of the DJIA, S&P 500 and NASDAQ Composite since 2001 with the weekly readings of the CBOE Equity Only Put/Call Ratio and the II’s Bullish and Bearish Advisors & as well as the difference between the Bulls and the Bears.
Most obvious on the charts is the 2009 bottom with Put/Call at 1.04 indicating more bearish put buying volume than call volume and the Bull-Bear differential at -32.2. You can see other recent major lows in 2001, 2002 and 2011 and how we are at a similar level currently with the Bull-Bear differential at -14.5. But Put/Call has not reached extremes yet and so far has peaked at 0.93. This is potentially creating an oversold bounce situation, but when compare to the average bear we are only partially there.
[Market & Sentiment indicator Chart]
Using the tables of DJIA, S&P 500 and NASDAQ Bull & Bear markets, found on pages 131 and 132 STA 2016, we see the average DJIA bear market since 1901 has lasted 402 calendar days and resulted in an average decline of 31.1%. S&P 500 since 1930 has similar averages, 30.2% decline in 379 calendar days. In NASDAQ’s relatively shorter life span its average bear has lasted 280 calendar days, but losses are typically larger at 36.3%.
With the Ned Davis bear market definition officially satisfied today, DJIA’s current bear market is 268 calendar days old and its loss stands at 14.5%. S&P 500’s peak was 266 calendar days ago (May 21, 2015) and it is down 14.2%. NASDAQ peaked 206 days ago (July 20, 2015) and its loss since then is now 18.2%. Compared to the average bear market duration and loss, the market is currently more than half way through duration wise, but less than half way based upon average losses.
Numerous indices overseas and domestically have satisfied the typical 20% decline definition of a bear market however, DJIA, S&P 500 and NASDAQ have not. Historically, there have been other times where numerous indices (or a commodity) was in a bear market (>20% decline), but other indices stopped short of the threshold. 2011 is a recent example of one such occurrence. Europe and emerging markets were struggling, DJIA slipped into a Ned Davis defined bear market, but DJIA found bottom down 16.8%. Just because one or more than one index falls into a bear market, this does not guarantee across the board bear markets.
An excellent example of this is the following comparison of S&P 500 20% bear markets with Russell 2000 20% bear markets. Since 1979, Russell 2000 has slipped into a bear market 12 times however, S&P 500 followed suit on only 5 occasions (shaded grey in following table). 
[S&P 500 20% Bear Markets]
[Russell 2000 20% Bear Markets]
Many indices, sub-indices and commodities have certainly satisfied the 20% down definition of a bear market, yet many others have not. U.S. economic data is tepid, but clear signs of a recession here have not materialized. We anticipate digger further into the anatomy of a bear market over the next several days with the goal of providing further clarification on where the market is likely headed next and trading ideas to make the next move a profitable one.