This Isn’t The Start of a Bear Market

Summary: Equities fell 4-5% last week and have given up most of their 2018 gains so far in October. This might feel like the start of a bear market, but that is the least likely outcome.

US equities fell 4-5% last week. The nearly 10% gain in 2018 at the end of September for SPX has been reduced to just 3%. Small caps have been hit the hardest and are now barely above their level at the start of the year (table from Enlarge any chart by clicking on it.

Our overall perspective from last month was the following:
Years with strong momentum and positive economic fundamentals, like 2018, have a strong propensity to continue higher to the end of the year.
But near-term (the next month) risk/reward is unfavorable and traders should be on alert for weakness.
It is unlikely that any equity weakness will be substantial or long lived.

Data supporting this view can be found here and here.

The bottom of the recent swoon may not be in but our view is that investors' bias should now be for higher prices in the weeks/months ahead.

That does not mean that investors should be complacent. At its low last week, SPX had retraced all of its gains from 3Q. You could, objectively, look at the August/September break out above the January all-time high (ATH) as having failed.

And here's the bad news: US equities have a topping pattern in place. Price weakens before it reverses. This is how tops are formed: there is a momentum high before an eventual price high as the uptrend falters. The momentum high for SPX was in January; in fact, momentum had not been higher in the past 40 years, a warning. Price eventually made new highs in August and September. This pattern is how every major top in the past 40 years has started. We wrote a post about this in August (here).