20% Don’t Mean Nothin’

Every so often, I threaten my TV with extreme violence. I’ve noticed that I’m almost always watching CNBC at the time. I know I shouldn’t do that but I must admit to a morbid fascination with pure idiocy.One of the stupidest things they say—and they say it many times a day—is that a 20% drop from a market high is a bear market. If the index is not down 20%, well then you must be in a bull market. Terms like bull and bear used to mean something. But not on CNBC.

A bear market is a market characterized by growing aversion to risk. You can be in a bear market 2% from the all-time highs—as I think we are now—and you can be in a bull market down 20% from the highs. A bear market is defined by the psychology of investors—market sentiment—not percentage moves in an index. When investors want to buy risky stocks and risky debt, you are in a bull market.

How do you measure investor sentiment? One useful measure is the NYSE Bullish Percent Index which was invented by market technicians at Chartcraft in 1955 (now known as Investors Intelligence). The NYSE Bullish Percent Index is calculated by reading either a buy or a sell signal from the point and figure chart of each of the 2,800+ stocks on the NYSE each evening. The value of the index represents the percentage of stocks listed on the NYSE that signal a buy. For example, if 2,100 stocks signal buy and 700 signal sell, the value of the NYSE Bullish Percent Index is 75. Since it incorporates every NYSE-listed company, it is easy to see how useful this index can be.

Below is the 5 year weekly chart of the NYSE Bullish Percent Index. Since around July of 2014, the index has been trending down— you can see the lower highs and lower lows. Bear market warning?

NYSE Bullish Percent Index

Another good thing to look at is the number of NYSE-listed stocks trading above their 200 day simple moving average. Below is a 5 year weekly chart of that indicator. Since around July of 2014, the trend is down. Coincidence? I think not.

NYSE Stocks above 200 Day Moving Average

Finally, I like to look at the ratio of high yield debt to the higher quality corporate stuff. Interest rates go up and down and they may not mean much in isolation. But when investors start to prefer lower risk, investment grade corporate debt over junk, you know that a bear market is likely on the way. Below is a 5 year weekly chart of the ratio of a high yield debt ETF (HYG) to a high quality corporate debt ETF (LQD). It started to break in September of 2014.

Screen Shot 2016-05-31 at 10.54.10 AM

The easy money has been made in the stock market and the bear has arrived. Risk off.