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Is It A Correction Or A Bear Market?

Submitted by John Murphy,

What Difference Does It Make?

There's a debate in professional circles as to whether the stock market is in a correction or a bear market. It makes a difference. Let's define what they are. A stock market "correction" is a drop of more than 10%. Most corrections average about -15%. A bear market is a drop of 20% or more. Bear market losses have averaged -30%, and last longer than corrections. The last two bear markets between 2000 and 2002 and 2007 to 2009 lost -50%. Those losses were much bigger than most bear markets. Those precise definitions can lead to problems however. The price bars in Chart 1 show the S&P 500 losing -21% during 2011 from May to the start of October. That qualified as a bear market.

 Closing prices, however, lost -19% which signaled a correction. I recall a debate at the time as to whether or not that qualified as a bear market. As it turned out, 2011 was only a correction. Moving averages "death crosses" often signal a bear market, but not always. Chart 2 shows the (blue) 50-day average falling below the red 200-day average during 2010 and 2011 for the SPX. [50 and 200day EMAs also turned negative both years].

The SPX lost -17% in 2010 before turning back up. That was also a correction. Bear markets don't always last a long time either. Bear markets in 1987, 1990, and 1998 lasted only three months, and bottomed during October. 

A LONGER-RANGE LOOK AT THE S&P 500...

The monthly bars in Chart 3 show the last two bear markets in the S&P 500 starting in 2000 and 2007 which lost -50% and 57% respectively; and the SPX reaching a new record in spring 2013 which ended the "lost decade" of stocks that started in 2000. The horizontal line drawn over the 2000/2007 peaks should act a solid floor beneath the price bars. A drop to that flat line would represent a drop of 26% which would qualify as a bear market. But that would still leave the SPX in a secular uptrend.

The rising trendline drawn under the 2009/2011 lows shows potential support near 1700. A retest of that support line would represent an SPX lost of 20% which qualifies as a bear market. Chartwise, however, an SPX drop into bear market territory (-20% to 26%) would still be within its long-term uptrend. So it might not matter that much after all whether we're in a "correction" or "bear market" as long as the secular uptrend remains intact.

S&P 500 RUNS INTO SELLING...

Last week, I used Fibonacci retracement lines over the Dow Industrials to identify levels where more selling was likely. Chart 4 applies those (red) lines to the S&P 500 measured from its July high to its August low.

The SPX has already run into selling near 2000 which was a 50% bounce. It has lost ground since then, but remains above last week's climactic low. The SPX will probably "back and fill" for a month or two in an attempt to repair recent technical damage. That would take us into October which has marked the bottom of most previous corrections. In the meantime, a retest of the August low wouldn't be surprising. That would be an important test. As long as last October's low remains intact, I will continue to lead toward the "correction" camp. But there are enough negative warnings to justify a very cautious stance.