The "under the surface" signals have been quite bearish for the past 1-2 years. Money has rotated away from aggressive areas and I've discussed it here and my Trading Places blog quite often. But it was very difficult to think bearish thoughts as long as the combination of price and volume remained bullish. So I've been waiting to get the bearish price breakdown before re-evaluating the market. That breakdown came last week during one of the most historically bullish periods of the year - strange indeed. Let's look first at the warning signs and price breakdowns prior to both the 2000-2002 and 2007-2009 bear markets:
The warning signs began more than a year before the S&P 500 actually topped as rotation away from aggressive areas of the market became quite clear. But despite those warning signs, the S&P 500 trudged higher a few more times until the weight of being led by defensive areas was too great. The final blows to the bulls came in late 2007 (price breakdown) and the second quarter of 2008 (failure at price resistance). Do you notice the volume spike in late 2007/early 2008 to accompany the price breakdown? That confirmed all the previous potential topping signals and began a very nasty bear market. Now let's fast forward to where we are now:
It's crystal clear to me that market participants have been moving away from risk for the past 1-2 years while the pace of gains in the S&P 500 have slowed. Points 1, 2, and 3 have provided us clues over the past couple years that money is becoming much more cautious and defensive as those points have marked relative ratio highs. Given the increasing volume this past week and the loss of 2100 price support, the odds are increasing that this is more than a simple profit taking pullback and we're beginning to confirm those earlier warning signs. If the selling escalates and the S&P 500 loses support in the 2000-2025 area and the relative ratios continue dropping, then I believe a new bear market is underway. But even without the knowledge of whether a bear market has begun, it's definitely time to adjust our trading strategies to minimize our downside risk. That would require hedges in place - selling covered calls, trading fewer shares, increasing our cash level, trading ETFs over individual stocks, etc. There are numerous ways to reduce risk and you should strongly consider choosing one way or another.
Finally, for those who are very aggressive and are interested in shorting, I'd use a short-term bounce on the S&P 500 to the 2100-2120 area as an opportunity to begin building short positions.