XTN - Closing In On Bear Market Territory

2023-09-26 13:06:25 ET

Summary

• There is growing debate on whether the U.S. can avoid a recession, given the most aggressive monetary policy since the early '80s.
• Avoiding an economic contraction is likely to be necessary to prevent an outright bear market in equities.
• Equities have turned down hard since the beginning of August, and many areas of the market are already between a correction and a full bear market.
• Can stocks avoid a full-blown bear market? A look at some discouraging charts and an analysis follows below.

It's a recession when your neighbor loses his job; it's a depression when you lose your own ."? Harry S. Truman.

There has been a lot of back-and-forth conversations among pundits as well as writers here on Seeking Alpha recently on whether the U.S. can avoid a recession amidst the most aggressive monetary policy since the days of Paul Volcker.

The one strong consensus seems to be that avoiding an economic contraction will be necessary in order to avoid a bear market in equities. Stocks almost always entered bear market territory whenever the economy enters a recession.

However, what if those arguments are moot as the market for the most part is already in or very close to being in a bear market? The classic definition of a bear market is at least a 20% decline in equities from their highs. The Chief Market Strategist, Tony Dwyer, at Canaccord Genuity noted on CNBC the other day that the average stock on the NYSE is down 29% from its recent highs after last week's rout in the market, which was the worst weekly performance since March for equities. Based on many key charts, the markets feel in reality they are between a correction (10% decline from highs) and a full bear market right now.

Transportation stocks usually signal stress in the economy and turn down in front of recessions. It certainly is not looking good on this front, as the SPDR® S&P Transportation ETF ( XTN ) is down some 17% since the beginning of August, right on the cusp of the official definition of a " bear market ."

Rising interest rates are playing complete havoc right now with the " high beta" parts of the market as well. The SPDR® S&P Biotech ETF ( XBI ) is off some 15% since mid-July. In addition, small and midcap biotechs are selling at less than half their levels of the start of 2021 and currently are at technical support at the same levels as of the end of 2015. The small cap iShares Russell 2000 ETF ( IWM ) is also off nearly 15% since the beginning of August as well.

Then, we have the iShares Semiconductor ETF ( SOXX ), which also tends to sell off heavily in front of economic contractions on a historical basis. The index is off nearly 15% from the beginning of August, and that decline appears to be accelerating to the downside.

Finally, even some of the " Magnificent Seven " are starting to spit the bit in the markets here lately. This is important, as the seven largest market cap stocks were entirely responsible for the 15.9% gain in the S&P 500 (SP500) in the first half of 2023. Without these mega caps, the S&P '493' was slightly down in the first six months of the year. Take Apple ( AAPL ) , which has the largest market cap in the entire market. The stock of tech giant is down some 12% from its highs at the start of August despite the launch of the much-anticipated iPhone 15. The shares are currently testing short-term support levels (below), and if the stock closes below $170, the equity could easily take another leg down.

As I noted in my article " The Pain Arrives " the other day, roughly half the portfolio is in short term treasuries currently yielding 5.5%. Approximately 40% is in mostly conservative covered call holdings. The rest is in cash as well as some bear put spreads positioned to benefit greatly from a continued downturn in the markets.

This is certainly not the most exciting of portfolio allocations. However, it has stood up well during the recent downturn in the market and is now up just over two percent since the beginning of August, while the overall market has sold off. I expect to continue keep this portfolio configuration until it finally dawns on more investors that the economy is heading into recession and the next bear market is right over the horizon.

Now, there will come a time when it will be prudent to make more than incremental moves on the long side. We are quite some time away from that point, however. Quite a few investors and fund managers seem to be waiting for the Fed to " pivot" and start to lower rates before they get more bullish on the markets.

Personally, I am watching the S&P VIX Index ( VIX ) closely. When it was trading in the 12-14 range in June and July, I established some large, long date bear market put spread positions against both SPDR® S&P 500 ETF Trust ( SPY ) and the Invesco QQQ Trust ETF ( QQQ ) . With a 20% decline in these major indices going out to the June and September expirations, I could attain an 8 to 12 to 1 return if a bear market scenario played out.

The VIX is now at 18, so I am no longer adding to those decent-sized holdings, which are well in the money given the recent declines in the markets. However, I won't be going long heavily and selling off those bear put spreads until the VIX gets in the 35-40 range. That will signal some panic and capitulation in equities, which is usually the right time to start to back up the truck from an investment perspective.

During recession greed dies, frugality survives ."? Amit Kalantri, Wealth of Words.

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