Phisix: On A Bear Market Template, Bear Market Rules Apply

``The failure to understand the dynamics of market cycles is a major reason why investors repeatedly overextend their risk near market peaks, hold onto their stocks over the full course of a bear market, and finally abandon stocks near market troughs. Though less than half of a typical bull market's gains typically remain by the end of a bear market, those bear markets rarely move in a straight line. Instead, they typically include several declines of 10-20%, punctuated by very hard rallies. As I've noted before, the 2000-2002 decline, which took the S&P 500 down by nearly half, included three separate advances of about 20% each (measured from intra-day low to intra-day high). These advances serve to keep investors “holding and hoping,” as Richard Russell would say.”-John Hussman

It is rare to have our projections (namely, oversold bounce, a rush of government policies, record high gold) come to pass immediately, as most of the time they take “eons” to transpire. But we won’t have to “pat ourselves in the back” over these short-term favorable outcomes because events may turn out to be fleeting.

In the ongoing epic struggle between market forces, manifested today by the adjustments brought about by debt induced deflation, and inflationary government intervention, signified by “safety net” policies aimed at cushioning its impact, the convulsive tensions from such conflict could be clearly felt in the markets. Tuesday headlines “Stock Market Plunges Worldwide” (Associated Press) was a clear depiction of such phenomenon.

As I have posted in my blogspot last Monday, “Phisix, Most Global Markets Enter Bear Territory” over HALF of the world’s indices has transitioned into bear markets as identified by Bloomberg, which included our own Phisix, shown in Figure 1.

Figure 1: stockcharts.com: Global Markets: Transition To A Cyclical Bear Market?

Technically, a bear market is defined as a drop of 20% from the top. And the underlying characteristic of bear markets is it “descends upon a ladder of hope” or that momentum implies the path of least resistance is likely to be a downward path. In short, expect negative returns. The paramount question is how deep and for how long?

For the Phisix, which as of Friday’s close is down 16.4% from its pinnacle last October, this highlights the second attempt to breach the psychological barrier of 3,000, but again due to oversold levels, the Philippine benchmark has violently recoiled and erased some of its losses (see Figure 1 main window). Again, data from PSE indicates that these intense selling could be attributed to the streak of massive net foreign selling since the advent of 2008.

Of course, we don’t deny that domestic dynamics has been tied to the events around the world, as we have been one of the “rare” contrarian iconoclast preachers of globalized correlation since 2003-when everyone was talking “micro”, although again we think that market dynamics could be shifting to “regional” than “global” in the near future (again another of our contrarian theme).

One remarkable observation today is that the Phisix has performed almost at par with US markets instead of suffering from severe drubbings of a far greater degree as seen in the past.

For the US markets which has served as an instrumental leader for global markets, 2 of its major indices like the Phisix crossed over into bear territories during the last week’s carnage but have regained some of its losses, namely the technology rich Nasdaq (down about 18% from its peak as of Friday) and small cap Russell 2000 (down 19%). On the other hand, the Dow Jones Industrials is down close to 14% and for the S & P 500 nearly 15% (upper pane in Figure 1).

All this implies is that our Phisix has now been transformed into a relative Beta play or near equal volatility with that of the US markets. Of course we expect this to change which we will elaborate later.

For the moment, the reappearance of risk aversion in the form of bear markets hound even emerging market stocks as represented by Asia ex-Japan (upper pane below center window) down about 17% and iShares Emerging Markets (lowest pane) down 19%-as of Friday’s close.

But with the realization that the direction of equity markets seems to have gradated into a bear market requires a new template for one’s portfolio management. In other words, some trading rules for surviving bear markets, Carl Swenlin of DecisionPoint.com gives us some great clues (emphasis mine),

``Oversold conditions should be viewed as extremely dangerous. Whereas in bull markets oversold lows usually present buying opportunities, in bear markets they can often resolve into more heavy selling.

``Overbought conditions in a bear market are most likely to signal that a trading top is at hand.

``While bear market rallies present great profit opportunities, long positions should be managed as short-term only.”

To translate for market participants of the Philippine Stock Exchange: The next attempt to successfully infringe on Phisix 3,000 could lead to a test on the next critical support at 2,550 possibly over the medium term (perhaps 3 months to one year).

Albeit, we don’t want to be too mechanical about this or depend stringently on such rigid technical outlook, because, it is of my view, that fundamentals will dictate on the markets in the succeeding events where the next series of downturns in Anglo Saxon markets will be met with lesser degree of declines in the Phisix or even a potential divergence.

But again under present conditions bear market trading rules should apply unless the Phisix reveals of prominent signs of divergences.