An Ugly Stealth Bear Market Is Playing Out Beneath the Surface

Selling Doesn't Do Much for Market Bears

The market continues to struggle on Friday morning as investors await February employment data and retail sales numbers. This economic news would typically be the main focus, with investors parsing every data point for clues about the strength of the economy and the likelihood of Fed rate cuts, but not this time. Both reports have been pushed to the background by the war in the Middle East, now in its seventh day, and an ongoing reassessment of the economic impact of the AI revolution.

The jobs number lands at 8:30 AM ET. January came in unexpectedly strong, which was a problem then and could be a bigger one now. Oil prices are surging with Brent crude up more than 18% this week alone, which may cause stagflation concerns and makes it less likely the Fed cuts rates. A weak jobs number raises recession fears. Neither outcome is particularly positive for a market that is struggling with tremendous uncertainty.

What the Indexes Aren't Telling You

It is an extremely tough environment and one thing that makes it even tougher is that the indexes are still holding up reasonably well while underneath the surface there is dark and genuinely ugly bear market action in many individual stocks.

The common definition of a bear market is a drop of 20% or more from the highs. As of Friday morning, the S&P 500 is down just 6.8% from its highs. The DJIA is off 5.8%. The Russell 2000 has dropped 8.2%. The Nasdaq 100 (QQQ) is the closest to official bear market territory with a decline of 17.5%.

Under the hood, roughly 38% of stocks in the S&P 500 are already in a bear market and about 65% are in correction territory, meaning they are down 10% or more from their highs. In the Nasdaq 100, approximately half of the components are in a bear market and 75% are in a correction. The indexes are presenting a much healthier picture than the stocks inside them.

This is not a new problem. If you have been reading my columns over the years you know I have never been a fan of using the indexes as the primary measure of market health. They cover up what is really happening underneath and they are favored by the financial media precisely because they make it easy to write a headline.

The DJIA down 5.8% from its highs is not a crisis. The fact that nearly two-thirds of S&P 500 stocks are in correction territory is a different matter entirely.

The Headline Problem

The disconnect matters because headlines influence sentiment. Right now they are creating the impression that the market is in considerably better shape than it actually is, and that makes it harder to generate the kind of capitulation and emotional exhaustion that eventually produces a real washout and a durable bottom.

With the indexes still looking relatively healthy, there is a greater inclination to bottom fish and remain optimistic about a quick turn. That causes the pain to drag out as each bounce or rally gets sold.

Following Thursday's poor technical action, Investors Business Daily cut its suggested market exposure to 20% to 40%. That is what you do in a bear market.

IBD focuses on price action and sector strength rather than whether an artificial construct has crossed the 20% threshold. They are dealing with the reality of individual stock movement and right now that reality is considerably darker than the headline indexes suggest.

The Question Worth Asking

The big question I am pondering Friday morning is whether we will need the S&P 500 and other indexes to actually hit the official 20% bear market threshold before this market can turn. If that does happen, it will be tremendously painful, particularly since so many individual stocks are already down substantially from their highs.

The greater likelihood is that rotational action eventually resolves some of the damage, but at some point the indexes may have to catch down to where the stocks already are. That is the nature of cycles.

Game Plan

Stay defensive and be patient. There are not many real opportunities right now and many traders are churning their accounts trying to capture intraday or very short-term volatility. That is a difficult way to make money in a choppy tape.

Maintain a watch list of high quality names with solid fundamentals and don't be in any rush to buy them. The next real trend will announce itself clearly enough that you will not need to guess your way in.

At the time of publication, Rev Shark had no positions in any securities mentioned.