Craig Martin: Another awful October to kickstart new bear market?

Craig Martin
Craig Martin

By Craig Martin*

October has often been painted as the worst month to be in the stock market. This is partly because some of the largest one-day declines in the Dow Jones Industrial index happened in the month of October.

On October 29, 1929, the Dow plunged 12.8 percent, and then continued dropping until it eventually lost approximately 90 percent of its value, ushering in the Great Depression.

Ironically, the crash of October 19, 1987 was much worse, when the Dow lost 22.6 percent of its value in one day. The slide continued for several weeks adding to the losses, before the market found a bottom that would hold.

The start of the last bear market was arguably October 9, 2007, but market meltdown really hit on September 29, 2008 when the Dow dropped by 777 points – the most in a single day up to that point, but it then dropped 800 points closing below 10,000 on October 6, 2008 and continued to plummet 13% over the month.

In an attempt to answer whether October could mark the start of a new bear market, I have used ten signals, which I have coined my “Ten Point Bear Market Barometer”.

I acknowledge that over the past few years many experts have attempted to call the beginning of a new bear market. We’ve heard the expressions like “wall of worry”, “double-dip”, “relief rally”, “kicking the can” and yet the market has continued to move higher. The truth is that the market is generally unpredictable and impossible to accurately time, which is why I am not making an analysis, but will leave you to consider the ten signals of my “Bear Market Barometer” and then you can draw your own conclusions.

1)    Dampened Euphoria

Sir John Templeton is quoted as saying that “Bull markets are born on pessimism, grown on scepticism, matures on optimism, and die on euphoria.” By the same token, bear markets must begin when euphoria starts to subsides, but there is still some subdued optimism in the air with investors looking to “buy the dips.”

The simple definition of a bear market is a sell-off of at least 20%. Even when the market has fallen by 10% at the start of a bear market, most investors will still be confident that this presents a buying opportunity. This stage that appears to be subdued optimism is really denial and it is often followed by disillusionment when the market does not recover from its initial fall, but goes on to fall further. This is followed by fear, desperation, panic and finally capitulation.

2)    Value is Scarce

The common signs of value tend to be low price:earnings (PE) ratios, higher than average dividend yields and companies trading at discounts to their book value.

At the start of 2013, the JSE was trading on an historical PE ratio of just more than 14x, with the long term average of around 12.5x. By June 2014, the historic PE ratio had moved up to 19x, almost two standard deviations above the mean. Dividend yields have declined and companies that once traded at 20-25% discounts to book now trade at the sum-of-their parts valuation of close thereto.

I think most analysts will agree that value is more difficult to find than it was this time last year.

3)    Company Prospect Statements

The view that Directors tend to have of their companies prospects are often a good indicator of the sort of earnings increases we are likely to see. The commentary on the results purely tells you what the market already knows and what is reflect in the current pricing. However, when Directors constantly warn that they expect difficulty in achieving similar growth rates, or that the next period is likely to be challenging, then this should be read as a warning that the bull market may be running out of steam.

4)    Interest Rates Rising

Certainly a driver for the interest in cash has to be interest rates and where we are in the local and global interest rate cycle. Bull markets tend to end when the interest rate cycle begins to turn and interest rates start rising again.

Global interest rates are certainly not rising now, but the market is forward-looking. It could be argued that rates are at levels where they cannot perceivably fall lower. The next expected move in most global markets is higher, which normally does not bode well for equities.

5)    Money Supply Drying

As a general rule, broad money supply tends to increase at the start of a bull market. The past five years have had unprecedented flooding of the market with money. The two big economies, namely the US and China seem to be seeing a slowdown in money supply. The US appears to have concluded its quantitative easing, even though the Bank of Japan and the European Union may still have “money to print”.

In South Africa, our M3 money supply ramped-up over the past few years, but seems to have tapered off over the past quarter, possibly because of a slowdown in credit granted. This global slowdown in new money entering the system often marks the end of a bull market.

6)    Money Flow

Large volumes during a sell-off are often an indicator of bearish sentiment. Over the past 3 trading days, the volumes on the S&P500 have been at least 20% higher than the average daily trade. The All Share closed down 2,16% on Friday (10 Oct) and over the prior three trading days on volumes that were only marginally higher than the daily averages. But, how do you get to grips with money flow over any significant period of time?

Marc Chaikin developed a money flow technical indicator, which uses both price and volume to get a more complete picture of the price action in the market. However, this indicator cannot be looked at in isolation, but there is research that seems to indicate that when money is flowing out of the market and there is a cross-over of moving averages (200-day and 40-day WMA), this could be an early warning signal of further downside.

7)    Cash Gaining Favour

In a bull market, cash is generally not the best possible asset class to own. However, when the smart money, namely institutional investors with flexible mandates, begins to find cash attractive again, it could be a sign that the bull is running out of steam.

Globally, cash yields have been at all-time lows, making this asset-class unattractive, but it looks as though this cycle is about to turn.  Some anecdotal commentary seems to indicate that certain asset managers are holding more cash now than they did earlier in the year.

8)    New Listings have Peaked

You don’t see new listing activity in bear markets, but certainly it is noted that listings are more plentiful in bull markets. We saw 12 new listings in 2013 and have seen the same amount of companies listing on the local market so far this year, but as much as 76 listings since the start of 2009. However, the number of IPOs in the US has been at its highest since before the financial crisis, and there have certainly been some large listings such as Alibaba. One would expect to see new listings being put on hold as sentiment begins to turn or uncertainty sets in.

9)    Party Talk and Media Comment is Changing

During a bull market, the stock market is a popular topic at the dinner table. When talk moves from discussions around gains made to concern about losses, there is still interest and attention on the market, but it is a sign that concern is setting in. By the end of a bear market, no one wants to talk about shares at social occasions.

It is not always the case that a bear market is imminent when the media becomes less bullish, but it could be. Normally the tell-tale signs are the reduction in media hype and a move toward more non-committal reporting – indicating possible uncertainty.

10)   There is a Looming Cause

Generally bear markets are not that random. Sometimes the catalyst is clearly recognisable after the fact, such as the announcement of a recession, the collapse of a financial institution, the outbreak of a war, or some other crisis, such as the oil crisis of 1973.  The challenge is to try and anticipate whether there is some looming macro or micro factor that could be the catalyst to a sell-off of more than twenty percent. Some of these causes may be termed “black swan” events, which are difficult to foresee, but other issues such as a recessions, deflation or imminent bubbles are ultimately ignored at investor’s peril.

This list is not intended to be exhaustive, not is intended to be a macroeconomic checklist, but simple to serve as a gauge to help determine whether we may be close to the start of a bear market.

October is a month of special attention for a number of reasons. For one, many companies begin their fourth quarter in October. For retailers and other companies with ties to the holiday shopping season, October is the beginning of the most intense and important shopping season.

So far the month has not started off very well, but whether or not this pullback presents a buying opportunity or not, I leave the verdict to you.

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