MARKETS

The negative message from key technical indicators has moved us to our most defensive position in over six years, cautions Jim Stack, editor of InvesTech Market Analyst.

We should also point out that even if this years starting weakness turns out to be a correction, there is valid reason to steer a more cautious course in 2016, as outlined in our previous issue.

At over six years of age, this economic recovery is one of the longer expansions of the past century.

Over the past 85 years, there have been 14 recessions (on average, one every four-six years), and nine of those recessions started in the year following a Presidential election.

Additionally, three others started in a Presidential election year (1948, 1960, and 1980). Considering that bear markets typically lead recession by nine-12 months, this is the time we need to be particularly vigilant.

Market performance in Presidential election years is also generally positive and significant losses are rare. However, the current 2013-16 Presidential election cycle is anything but average.

Years one and two of the Presidential cycle were far stronger than usual, while 2015 saw the first negative S&P 500 return for Year three since 1939.

Likewise, 2016 is also starting off on the wrong foot for a Presidential election year. Clearly, this election cycle is out of sync with the historical norm.

One certainty that we warned about over a year ago in December 2014, is that volatility is heating up. There were almost twice as many 1% and 2% daily moves in the DJIA last year than in the previous three years. This rising volatility is more common in a developing bear market.

Near the top of our list of technical concerns is the negative divergence in breadth (Advance-Decline Line) and bellwether stocks.  If this is still a bull market, it is not a healthy one.

To some extent, this is already a silent bear market. While the S&P 500 Index and DJIA are off less than 12% from last years high, the Dow Jones Transportation Average is down -27% and the small-cap Russell 2000 Index is down -22%.

In addition, 51% of the stocks in the S&P 500 Index are now down over 20% from their highs last year.

There are only three corrections in the past 35 years in which the Transports and Russell 2000 fell -20% and the blue chip indexes didnt experience a bear market: the 1983-84 correction, the 1998 Asian Financial Crisis, and the 2011 correction. The other ten instances developed into full-scale bear markets.

We are not prepared to say we are in a bear market…at least not yet. In the meantime, these technical warning flags are reason enough to err on the side of caution as we traverse this tumultuous year.

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