S&P 500 in Stage 3 of its Bear Market Move: BofA

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Bank of America Global Research have turned to one of the veterans of technical analysis to try and predict how far the current decline in the S&P 500 will extend and find there is further to go.

Bob Farrell, one of the pioneers of technical analysis who worked at Merrill Lynch for over 45 years, developed some compelling rules that could serve us well now say analysts at his old employer.

Farrell said bear markets have three stages: a sharp decline, followed by a reflex rebound and then a drawn-out fundamental downtrend.

Farrell is retired but his protégé at Bank of America Merrill Lynch, Stephen Suttmeier, says we are likely in the third stage of the bear market, with risks the S&P 500 moves to 3800 (20% correction) and even 3500 (27%).

"An equity bear market, the highest inflation in 40 years, a Fed hiking cycle and Value vs Growth are all causing deep investor concerns. Farrell’s rules suggest that equity corrections are normal, the upward reversion for interest rates can continue and that a bigger rotation to Value from Growth is underway," says Suttmeier.

A look at the S&P 500 weekly chart shows the current location of the 200-week moving average, an important technical indicator that could ultimately spell out where the market is headed:

Above: The 200 day weekly moving average shown on the weekly S&P 500 chart.

As the chart above shows, in the past drawdowns have fallen to meet the 200-week moving average and if the current drawdown respects this pattern further declines are incoming.

This matters for a host of financial assets, including the Pound which has a 'high beta' to this U.S. index.

"Cyclical bear markets within secular bull markets tend to mean-revert toward the rising 200-week moving average on the S&P 500, a key 2022 support near 3500," says Suttmeier.

But could this time be different, i.e. could the S&P 500 and risk turn direction earlier than it meets the 200 week moving average?

Suttmeier says Farrell's rules state there is no such thing as a 'new era'.

"When investors talk about a new era, run the other way. It just means excesses have been built up, the big move has already happened and sentiment is too extreme for the trend to continue," says Suttmeier.

The Ten Rules

1. Markets tend to return to the mean over time
2. Excesses in one direction will lead to an opposite excess in the other direction
3. There are no new eras — excesses are never permanent
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
5. The public buys the most at the top and the least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names
8. Bear markets have three stages — sharp down — reflexive rebound — a drawn-out fundamental downtrend
9. When all the experts and forecasts agree – something else is going to happen
10. Bull markets are more fun than bear markets