Should you buy equities amid the US stock market entering bear market territory?
- S&P 500 is in a bear market
- Not all bear markets led to a recession
- Falling wedge pattern signals a possible reversal
Last week, the S&P 500 index plunged into bear market territory. It made a new all-time high at the start of the trading year but moved in only one direction since then – lower.
When a market drops by more than 20% from its highs, it enters bear market territory. The drop is not surprising, given that the Federal Reserve of the United States has raised the interest rate by 75bp and plans to deliver another similar hike in July.
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A quick comparison of bear markets from the past reveals a few possible outcomes. The smallest decline happened during the Barings Brothers Crisis in 1890 – about 20% from the highs. On the other end, the crash of 1929 that marked the first part of the Great Depression registered a decline of 86.2% from the highs.
Therefore, one may say that any bear market should see a decline by at least 20% and a maximum of 86.2%. We might, therefore, be just at the lower end of the range.
During last week’s Fed presser, Jerome Powell, Fed’s Chair, was questioned about the possibility of the US economy entering a recession. Many traders associate a bear market with a recession, but that is not necessarily true.
For instance, in 1987, the S&P 500 entered a bear market that lasted four months (i.e., from August to December), and the decline exceeded 34%. But the US economy did not enter a recession.
So is the current drop into a bear market an opportunity to buy stocks at discounted prices on a bet that the US economy would not enter a recession?
Head and shoulders pattern confirmed, but a falling wedge signals a possible reversal
The technical picture reveals a head and shoulders pattern confirmed by the recent price action. After the market travels the minimum distance to confirm the pattern (i.e., the measured move, seen in orange below), the path of least resistance remains the downside.
However, a falling wedge pattern signals a possible reversal. A move above 4,000 implies the upper edge of the pattern is broken. Furthermore, an advance above 4,200 and thus, a move above the neckline, signals a possible invalidation of the head and shoulders pattern.
All in all, the levels to watch in the S&P 500 index are 4,000 and 4,200. A rally above the two should see momentum and a further squeeze is possible.