‘We are in a bearish environment’: veteran trader

Bearish warning signs are flashing in the markets, but that doesn’t mean U.S. stocks are in a bear market or even that one will develop.

“I’m not one to call for a bull market or a bear market, but we’re in a bearish environment. It’s easier for stocks to come in under pressure here,” says Brian Shannon, founder of AlphaTrends.net.

Shannon breaks down how he reads the market to look for signals. “I don’t look for a top in the market,” he says. “I listen for the message of the market on a daily basis and see how that fits together in the weekly time frame, the monthly time frame.”

Many of the current warning signals began surfacing toward the beginning of March. “[I]t started to become a little bit more difficult to make money on the long side with just about anything. And then what we started to notice was that there were a lot less, actual official swing trading ideas… [T]hey were coming from groups that we don’t normally consider growth-type names — names like Heinz (KHC), Weight Watchers (WW), blue chip-type names. And then… we started getting stopped out of our longs.”

JC Parets, founder of allstarcharts.com, has also been documenting the increasingly “messy” market and defensive posture.

“When Consumer Staples bottomed out on March 1st relative to the rest of the market, that was one of the first signs of defensive rotation. At the time, we chalked it up as just one signal, of many that we monitor. But as the month has progressed, the soldiers continue to fall. Aussie/Yen has rolled over and we’re even getting a bid in US Treasury Bonds,” writes Parets.

The 10-year yield (^TNX) recently surged to 1.75%, a level not seen since January 2020. This reflected expectations for a successful reopening of the global economy and coincided with stocks in the value and cyclical sectors outperforming. Meanwhile, growth tech and momentum names that were the stars of 2020 took a back seat. Tellingly, the Dow Jones Industrial Average (^DJI) surged to fresh all-time highs thanks to a boost from names like Walgreens Boots (WBA), Caterpillar (CAT), Boeing (BA), JPMorgan (JPM), Goldman Sachs (GS), Dow Inc. (DOW) and Chevron (CVX). But the Nasdaq Composite (^IXIC) failed to notch a record, falling short by 5%.

A YFi Interactive heat map of the Dow Jones Industrial Average components reveals that stocks in the value and cyclical sectors are holding the biggest gains, as tech names stumble (with the notable exception of Intel).

A YFi Interactive heat map of the Dow Jones Industrial Average components reveals that stocks in the value and cyclical sectors are holding the biggest gains, as tech names stumble (with the notable exception of Intel).

None of this is to say risk markets are set to crash or that it’s time to short everything.

Parets says, “As long as US Financials are above those 2007 highs, it’s tough to make a structurally bearish case. The weight-of-the-evidence suggests this is just a messy environment within a larger more macro advance for stocks.”

He also highlights the bullish breadth thrusts in stocks over the last year, where large numbers of stocks all advance simultaneously. “This first wave off the lows last year was tremendous. All those breadth thrusts we’ve seen since June, and even through January this year are characteristic of early cycle behavior. These thrusts historically show up near the beginning of bull markets, not near the end of them. But one common denominator among all of these longer-term bullish environments, is that there were corrections along the way.”

Markets can correct through both price and time — eventually working off excesses and settling into equilibrium, waiting for the next catalyst.

Parets doesn’t know how long it will take for markets to set up for the next big move. However, he is looking at the energy sector for clues. “One tell will likely be how long it takes for Energy stocks to digest this overhead supply from those former lows in early 2016,” he says, referencing a chart of the Energy Select Sector SPDR Fund (XLE). “We’re also looking for Small-caps, Mid-caps and Micros to get back above those February highs. But again, how long will that take?”

XLE recently bumped up against prior support, which is now resistance.

XLE recently bumped up against prior support, which is now resistance.

In the meantime, investors may reduce position size, raise stops on positions to limit risk, go bargain hunting for Buy and Hold names (reducing their cost basis) — or simply turn off the screens.

“It’s a frustrating time for trend followers, just like how in prior trending market, the mean reverting community got trampled. There’s a time and a place for everything. For me, it’s about first identifying the market environment, and then finding the tools and strategies that are best for that particular world,” says Parets.

As always, know your time horizon and objectives, and have a plan.

“There are times to make money in the market, and then there are times to keep your money. In sports, you play offense and you play defense,” says Parets. “Offense sells tickets, but defense wins championships.”

Jared Blikre is a reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared