Bear Market Roadmap

The Regime Shift Is Upon Us


The weight of the indicator evidence measured by the Fox Capital research framework now confirms that October marks the beginning of a significant regime shift with respect to market trend, trading patterns and volatility.  We’ve been anticipating this critical shift since we launched the Trystero Fund in January, as all the necessary preconditions have been met. Below is a list of factors we’ve highlighted as components of this precarious Bear Market set-up:


•The ETF Bubble has reached its bursting point, with slower inflows to equity funds, and recent outflows from bond funds.

•Equity markets are historically extended, as the US Bull Market has now achieved record status with respect to duration and magnitude.

•Valuation metrics are extreme by most measures, with the total US stock market cap / GDP ratio back to the bubble highs of 2000.

•Earnings revision breadth is falling precipitously in the face of peaking earnings growth.

•Corporate leverage is at all-time highs.

•Monetary conditions are tightening with a Fed hiking cycle and balance sheet reduction program well under way, and newly initiated tapering programs from the ECB and BOJ are adding to liquidity pressures.

•Global economic growth outside the US is slowing, and emerging markets are being punished by a strong dollar.

•Annualized volatility measures across most asset classes achieved record lows.

•Investor sentiment remains complacent with brokerage cash balances at historically low levels.

•The “buy the dip” mentality has become fully ingrained in investor psychology as a fool-proof formula for alpha.



Long-Established Uptrends Have Broken


With all these conditions in place, it was no surprise that volatility reared its ugly head again last month, wreaking havoc on investor performance while also causing significant damage to the technical health of markets.  Asset bubbles burst when severe losses pile up quickly, triggering the inevitable transition to new patterns of behavior.  As the broken long-term trend lines below illustrate, that trigger has been pulled. 



Change in Behavior


We believe October marked a turning point.  Simply put, long-established market trends have been broken and trading patterns have changed. While most investors will not recognize this before it’s too late given today’s dogmatic belief in “buy the dip” strategies, we are prepared not only to weather the coming storm, but to capitalize on the host of new opportunities such a regime shift will provide adept managers.  Those who are able to anticipate, identify and exploit emergent patterns driven by the changing dynamic of flows from the bubble bursting will stand out from the ill-equipped crowd. Buy-and-hold index strategies will suffer, while managers with the proper tools and technology will prosper.  The passive investment peak is in, and now is the time when robust active strategies and truly alternative investment vehicles are required.




Following the Playbook


We believe this transition to a new regime for risk assets is just beginning. Bear markets progress in distinct phases (median decline and duration for each phase depicted below). It begins with an initial decline that catches investors off guard and does a lot of damage fairly quickly (down 11.2% in 50 days). This first decline is followed by a fairly powerful rally as people buy the dip in full force, unafraid of a protracted decline (up 8.4% over 29 days). This cruel bull-trap gives way to a far more painful down-leg which causes investors the bulk of their losses (down 29.3% over 105 days). We believe this punishing 3rd phase is next. Let’s be careful out there.