The cycle of bear and bull markets is inevitable, but every cycle has unique characteristics. Understanding those characteristics will give you an edge in producing superior returns.
The most notable and consequential characteristic of the current corrective cycle is that it has been highly rotational and uneven. Many stocks topped out in February 2021 and have been in long, grueling downtrends. The indexes and big-caps did not start to come under pressure until more recently, and we still do not have technical bear markets for the S&P 500 and Dow Jones Industrial Average.
By comparison, the bear market in 2020 was extremely coordinated and occurred at record speed. That was due to the sudden appearance of the pandemic. The current bear market has had more complex catalysts, primarily a more hawkish Fed, raging inflation, supply chain issues and growing concerns about economic growth.
The biggest mistake people make in the current market environment is assuming that the S&P 500 or, even worse, the Dow Industrials, are reflective of the entire market. The truth is that these indexes are highly deceptive and do not reflect the action in the majority of stocks.
A very good example of this is the conditions that have led to the current market bounce. While the indexes were hitting new lows, the number of individual stocks that were hitting new lows was declining quickly. This disparity was a clear signal that many of the secondary stocks that have been under pressure for over a year were finally finding support and ready to bounce. That bounce started to gain some traction over the past two weeks after the number of new lows hit a stunning 3,000 names.
The critical point here is that the market corrected in a rotational manner. I referred to it as a stealth bear market for a very long time because it was so hidden by the indexes. It is very likely that we are going to see a stealth bull market in areas of the market now while the indexes grapple.
There will be times when the action will be highly correlated with all stocks moving in tandem, but look at the charts of individual stocks and compare those to the charts of the indexes. Those names that are showing better relative strength and productive patterns are the ones to focus on while the indexes do something else.
Don't be too concerned about the indexes. Watch individual stocks and sectors and track new lows and breadth. That is where the opportunities lie.
We have some follow-through momentum in the early going, but it is tentative. Trading is often thin and has a positive bias in front of a three-day weekend, but it can be very random. I'm looking for more upside but will manage positions tightly and take some profits into strength.
