A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Friday. (Photographer: Michael Nagle/Bloomberg) 

Dip Buyers Beware, the S&P 500 Bottoming Process Can Take Time

(Bloomberg) -- Convinced the stock rout is over? It has occasionally felt like it, on days like Friday, when the Dow Jones Industrial Average soared almost 750 points. Isolated examples of quick rebounds loom large in the minds of traders, or at least those whose careers go back more than a few years.

But even in a benign scenario -- one in which a bear market is avoided and the Boxing Day low in equities is preserved -- it’s wise to remember that bottoms usually take much longer to form than they have so far in the S&P 500 Index.

Here’s the data: since 1950, the S&P 500 has endured 11 retreats of 12 percent or more that happened in prolonged bull markets such as the current one, according to Bank of America. While the average decline of 19.9 percent matches the latest sell-off that started in October, the corrections have typically lingered for much longer -- eight months, on average.

Dip Buyers Beware, the S&P 500 Bottoming Process Can Take Time

In other words, even if a market bottom is close in terms of equity prices, it may be too early to call all clear yet if history is of any guide. As much as bulls are hoping President Donald Trump is right -- that the worst December since the Great Depression was merely “a little glitch” -- past patterns suggest it isn’t that simple.

From U.S.-China trade tensions to uncertainty over Federal Reserve monetary policy, issues that were at the center of the fourth-quarter equity rout haven’t gone away. Meanwhile, bad news keeps creeping in. Apple Inc. and Delta Air Lines Inc. just joined a growing list of companies in cutting financial forecasts, reinforcing fears that a slowdown in 2019 profits may be worse than analysts anticipated.

“We would not describe recent action as a ‘glitch’ but instead another piece of evidence that the long, powerful U.S. bull market may have ended in late September,” said Michael Shaoul, chief executive officer at Marketfield Asset Management LLC. “We would play the market going forward by ‘bear market rules,’ which suggest that rallies generally fail below desired targets and experience their strongest gains in a few brief sessions.”

That kind of bounce is happening now. Fueled by its post-Christmas rally and Friday’s surge, the S&P 500 climbed almost 8 percent in seven days, capping its first back-to-back weekly gains since early November. The rebound, coming after the benchmark fell within points of the 20 percent bear market threshold, is reminding some investors of two previous near-death experiences.

In 1990, the S&P 500 plunged 19.9 percent in three months through October only to erase all the losses four months later. In 1998, the market took a similar dive in a matter of weeks, and again, the decline was all but forgotten in two months.

Will stocks repeat this time? They certainly could. But large-scale market dislocations seldom end swiftly. Assuming stocks had bottomed on Dec. 24, this sell-off would rank as the fourth-fastest among the 11 pullbacks tracked by Bank of America. But if it matches the average length of the past routs, stocks would face more pain into the second quarter.

“The S&P 500 has experienced the average/median pullback in terms of price but not in terms of time,” Stephen Suttmeier, a technical analyst at BofA, wrote in a note Wednesday. “A rally and retest and/or undercut phase could complete the correction in terms of both price and time.”

The S&P 500 revisited what were then 10 percent declines in October and November -- and they didn’t hold. Now, past support levels have turned into hurdles.

Dip Buyers Beware, the S&P 500 Bottoming Process Can Take Time

The range between 2,530 and 2,600 represents “formidable resistance” for the S&P 500, according to Jonathan Krinsky, a technical analyst at Bay Crest Partners. The former marked the market’s bottom in February while the significance of 2,600 can be seen from its ability to have stemmed losses in May and October.

After attempts to top 2,530 failed on Dec. 28 and again on Jan. 2, the S&P 500 finally broke the threshold Friday. Still, at 2,531.94, it stood one point below February’s intraday low. To Rob Ginsberg at Wolfe Research, a dip to 2,200 on the S&P 500 during the first quarter is “a fair bet”.

“Counter-trend rallies can be violent,” Ginsberg said. “But given the structural damage, it will take time for these wounds to heal.”

©2019 Bloomberg L.P.