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As I have explained many times in the past twelve months, the bull market of 2009-2014 is coming to an end. I have written a number of articles on ADFVN about the impending reversal in global stock markets. Yes, I know there is a large proportion of bulls, I don’t have the exact number but it could be 80% or more but that does not matter. Most people believe the bull market will continue, yet history tells us that bear markets start when they are least expected. The high proportion of bulls by historical standards is a sell signal.
Firstly, bear markets start when there is an extreme in bullish sentiment and this is where we are now, that’s why very few investors will anticipate a bear market. Secondly and prior to the start of a bear market, we often see some divergences between the indices, when stock markets don’t confirm each other. If you check the daily chart of FTSE 100 you will notice that the UK index has lagged the S&P 500 for months. The FSTE 100 has underperformed the S&P 500 since February 2013. Basically the S&P 500 keeps climbing but the FTSE is not following.
On the chart this weakness is highlighted by the declining relative strength line (in blue). This line measures the performance of the FTSE 100 vs the S&P 500. In fact there are four reasons to believe that a bear market is underway:
1. Non confirmation between the FTSE 100 and the US markets
2. A possible ending diagonal pattern on the daily chart. This pattern is characterised by overlapping waves resembling a rising wedge. This pattern is bearish
3. Five waves up within the ending diagonal
4. A break below the lower trendline indicating a potential trend reversal
In today’s markets the FTSE 100 is the leading index, when the FTSE 100 does not follow the S&P 500 higher, the stock market is in trouble.
Stock markets fell hard yesterday and today the FTSE broke below the previous low set on 8 August. The lower trendline is broken too and prices are well below the 200-day moving average. The S&P has turned down and is catching up with the FTSE. Contrary to popular belief, the FTSE is the leading index. When the FTSE lags the S&P on the way up, it is a warning that stock markets will go down.
In addition sentiment as indicated by my sentiment indicator (ESI) has turned bearish. In a period of negative mood, the news takes another dimension. Take the Ebola case in the US. According to the media the market tumbled yesterday on Ebola fears. The real reason is because sentiment is bearish and the manufacturing PMIs across Europe, the UK and the US were all disappointing. One could think that the market should have rallied as the Fed is now less likely to raise rates but sentiment is bearish. When investors are not in the mood to buy stocks the good news is less relevant. Instead investors focus on the bad news which is the Ebola scare and weak manufacturing.
The sharp decline has now pushed the Top 20 Differential (timing indicator) to oversold. The FTSE is in a support area and a strong rally will unfold over the next two weeks. It’s too late to go short now but if history is any guide, this oncoming rally will provide a great opportunity to go short.
Thierry Laduguie is Trading Strategist at www.bettertrader.co.uk
