The Bear Pill

At the risk of looking like a fool, I'm calling the top. I do not know the day the Bear will come to the headline indexes, but I sense his arrival is imminent. I have written about this over the past month. Posts such as This Might Be A Big One. I made a disinflationary/deflationary case in Asset Inflation Is Over, For Now and an inflationary one in Inflation Bu Hao, Very Bu Hao. I'm well aware that I may be suffering from confirmation bias, but I think the reason I see a down market outside of a "Goldilocks" scenario is because sentiment and valuation have finally peaked. At the top of Everest, it doesn't matter which way you go: the next step is down.

I think market tops and bottoms are sometimes crystallized by a narrative or meme. Not always. The top in 2007 was kind of uneventful, but Citibank cutting its dividend a month or so later was a sign of the major trouble coming to financials. I distinctly remember a chart of money market fund totals going around on the Friday before the market bottom the following Monday in March 2009. I also remember people talking about General Electric going bankrupt that Friday. I remember thinking in the back of my mind, "This is probably the bottom." I didn't act on it, but I remember it. This post is what has me thinking, "This has to be the top."

On to the Bear Pill.

Yesterday, someone on social media was asking why the market is at new highs and they are down big. I went searching for "stealth bear market" because that was a popular term starting around 1998. Blue chip stocks were not rising with the market because gains were increasinly concentrated in tech. I came across this post from Top Gun Financial: The Stealth Bear Market And The Nature of Bull Market Tops.

I want to focus in on the epic tops of 1929 and 2000 because I think they are most similar to what we are seeing now. As you can see, when the market topped on 9/3/1929, 32% of stocks in the DJIA were already at least 20% below their highs and 19% were at least 30% below. On 1/14/2000, the numbers were 55% and 32%. These compare favorably with the numbers cited from Strazza’s post earlier on the NASDAQ in my opinion.

He's referencing what he wrote above in that post:

It starts with an excellent blog post by Steve Strazza of All Star Charts today entitled “Are Stocks In A Bear Market?” While the overall NASDAQ is less than 5% below its all time closing high from September 3rd (15,364) at today’s close, beneath the surface there is carnage. As you can see in the chart above, 51% of NASDAQ components are at least 20% below their 52 week highs and 25% are at least 50% below their 52 week highs.

I don't know the current numbers, but given the declines I've seen, I assume the numbers are worse now.

Going a little deeper into a top comparison, here's the one-month performance of the S&P 500 sectors:

Tech is up there and that's not exactly bearish, but communication services is rather tech-heavy with stocks such as Google and Facebook. Consumer discretionary has about 40 percent between Amazon and Tesla. On net, tech is taking on water. Consumer staples, utilities and real estate are all "defensive" sectors. Defensive is a misnomer because these sectors will all decline in a bear market, but they go higher during the topping process because nervous investors buy them.

Here are charts of the utilities and consumer staples SPDRs in 2000, and then compared to technology. Utilities peaked in November and staples in December. Both made their all-time high 8 to 9 months after the dotcom bubble had burst. Between March 24 and December 29, 2000 (simply the slice I grabbed when highlighting the chart), the returns for XLU, XLP and XLK were +32 percent, +41 percent and -51 percent.

Here are the same charts now. Utilities and consumer staples are trailing technology.

XLK has run up, but perhaps FDN is more representative—it peaked in July. For my money, ARK Innovation ETF (ARKK) is the appropariate stand-in. Against these funds, utilities and staples have been leading since February (ARKK) and July (FDN).

As of this moment, utilities peaked in September. Staples broke out on Friday with a big green candle. My explanation for this: many investment managers have a mandate that requires they remain 100 percent invested. As long as money is coming in, they have to put it somewhere. When utilities and staples start leading, it tells you they are nervous. Buying has shifted.

Going back to that one-month performance chart. What exactly has been driving strength in technology? Apple, and to a lesser extent Microsoft. The former is 23 percent of XLK and the latter 22 percent for a whopping 45 percent of the tech sector. Behold, the 1-month heat map of the S&P 500 stocks:

The gain in Apple alone is about 4.9 percent of the tech sector's gain. Back it out, and technology was down 0.4 percent in the past month. Microsoft was another 0.75 percent of performance. Both stocks are still in bullish uptrends. If they keep rising as they have, tech, the S&P 500 Index and Nasdaq could still rise. Can they keep rising? Microsoft has better technicals, but Apple is overbought on the daily, weekly and monthly timeframes. All it will take is a simple reversal and,

The "bull market," such that it even exists, has been all Apple the past month. Back it out and the S&P 500 and Nasdaq join the DJIA and Russell 2000 in the red for the month ended December 10.

The bull take is Apple signals the market is still bullish. Everything else will recover and the market will go on to new highs. Narrow markets in tech have happened a few times before in recent years and they always resolved higher. "This time is not different."

The bear view says the S&P 500 new all-time closing high made on Friday is an illusion created by one stock. It isn't a case of cherry-picking when the cherry is this big. The market is propped up by a handful of stocks with large weightings in the indexes. Apple and Microsoft are 6.92 percent and 6.32 percent of the S&P 500 Index. When one or both reverse, it will be like pulling the plug in the bathtub. Everything is going down.