We’re Inching Closer to a Bear Market Warning

Jan 28, 2022

It was another rough week for the markets.

Last week’s sell-off continued on Monday, with the major indexes suffering their worst intraday declines since the COVID-fueled crash in March 2020.

Stocks were able to recoup some of these losses over the past few days. However, the decline caused some important changes to the market’s health I want to share with you today.

First, as you can see in our TradeSmith Market Outlook tool below, several more indexes moved from the Health Indicator Green Zone into the Yellow Zone this week.

These include the large-cap S&P 500 (SPX) and Russell 1000 (IWB) indexes, the mid-cap S&P 400 (MID), the small-cap S&P 600 (SML), and Australia’s S&P/ASX 100 (XTO.AX).

More importantly, you’ll also notice that the small-cap Russell 2000 (IWM) became the first notable index to fall into the Red Zone since this pullback began. (Hong Kong’s Hang Seng Index moved into the Red Zone last summer following the Chinese government’s crackdown on markets.)

Now, I explained the details on our Health Indicator system when we discussed trailing stops last year. But if you’re not familiar, it works kind of like a traffic light.

Green means “go”: Assets in the Health Indicator Green Zone are behaving normally and are in a healthy state. At TradeSmith, we usually consider these assets a “buy.”

Yellow means “proceed with caution”: Assets in the Yellow Zone have pulled back more than halfway toward their Health Indicator trailing stop loss but are not yet in an unhealthy state. These assets are usually a “hold.”

And of course, red means “stop”: Assets in the Red Zone are in an unhealthy state. They have fallen below their Health Indicator trailing stop loss and are not behaving normally. These assets are usually a “sell.”

This color-coded system works the same for market indexes as it does for individual assets.

The bad news is that the Russell 2000 itself is no longer trading in a healthy state. If you own this index directly through a mutual fund or exchange-traded fund (ETF), we recommend selling if you haven’t already.

However, the good news (for now at least) is that this index has NOT yet triggered our powerful Bearseye signal.

I’ve explained this bear-market signal in detail previously as well.

In short, to trigger a Bearseye, an index must meet two specific criteria:

  1. The index itself must fall into the Red Zone (like the Russell 2000 just did).
  2. At least 40% of the component stocks that make up that index must fall into the Health Indicator Red Zone no more than two days after meeting the first criterion. (We can track this under our Market Outlook tool’s “Health Distribution” column above.)

In other words, a Bearseye triggers when an index, and at least 40% of the stocks within it, become “unhealthy” at the same time.

When a Bearseye alert occurs, it appears as a small red crosshair symbol on the charts in our system. This chart of the S&P 500 from February 2020 shows what this looks like.

As I mentioned before, our research shows that the Bearseye would’ve correctly predicted every bear market and significant market decline over the past few decades.

As a result, we take them very seriously when they occur.

That means we don’t just recommend selling any mutual funds or ETFs that directly track that index (like we do following a Red Zone alert).

When a Bearseye appears, we also recommend selling any stocks you own within that index, even if they’re still in the Green or Yellow zones.

(If you’re not sure if a stock is in a particular index, you can easily find that information with a quick internet search. TradeSmith subscribers can also access it directly from our Market Outlook tool.)

In addition, if several Bearseye signals trigger in multiple indexes around the same time (like we saw in February 2020), conservative investors may wish to get out of stocks entirely until the “dust” clears.

As I’ve mentioned before, that’s precisely what I did with my own portfolio when those last signals occurred in early 2020, and I’m so thankful I did.

It saved me a ton of unnecessary stress and anxiety when the market was crashing. And it ensured I had plenty of cash available to pick up bargains when the market bottomed several weeks later.

These are just general recommendations, of course. You may choose differently based on your financial situation and risk tolerance.

For example, super-conservative folks may choose to get out of stocks completely following one Bearseye in a single market index.

On the other hand, those who are comfortable taking more risk may prefer to continue holding Green Zone stocks until they hit their stop loss, regardless of the Bearseye.

Now, let me be clear…

We have not yet seen any Bearseye signals appear in any of the major market indexes in this sell-off so far.

And there is no guarantee that we will.

However, I want you to be prepared for that possibility in the days and weeks ahead.

And as promised, if we do see Bearseye signals in any of the major market indexes, we will alert every Money Talks reader immediately — whether you’re a TradeSmith subscriber or not.

It’s just a small way of saying “thank you” for your support.

One last thing…

Bearseye signals can also appear in individual market sectors based on the same two criteria I mentioned earlier.

These sector-based signals don’t carry the same broad-market implications as the major indexes. So we won’t be sending out notifications to Money Talks readers if they occur.

However, because they can be useful predictors of sector performance, I wanted to mention that one sector — Communication Services (XLC) — fell into the Red Zone AND triggered a Bearseye this week.

As a result, conservative investors may wish to sell any remaining stocks in this sector — including those in the Green and Yellow zones — today.