Is a Bear Market Brewing? What to Watch and How to Prepare

Please, don’t get too comfortable with your portfolio, not now. 

There are several pieces that have moved into motion over the last week that may have stinging results on the stock market and your net worth.

Benjamin Franklin said, “If you fail to plan, you are planning to fail!”

This is one of those moments to start putting your plan together.

What’s Changed?

This has little to do with DeepSeek, though the timing of the Chinese AI LLM is going to be a thorn in the side of the semiconductor sector.  

No, this has to do with a series of relatively slow-moving events that may culminate with our first real bear market in more than two years.

This doesn’t happen overnight, but I am going to give you a few indications to watch to help you know when to expect things to get more serious.

1. The Fed and Interest Rates

Last year, right about this time, the market was giving off a huge sigh of relief as investors finally saw hope that the Fed would start lowering interest rates.

We had been through a multi-year bout with inflation that famously had been referred to as “Transitory” for more than six months.  We know now that there was nothing transitory about it, inflation was ravaging consumer’s spending power.

In late 2022, the writing on the wall came into view.  The Fed was going to have to get serious about inflation by raising interest rates.

Interest rates are the Fed’s main tool for battling two things, inflation and recessions.  

Investors hate higher interest rates.  Higher rates affect the availability of capital in the economy, essentially squeezing growth like a boa constrictor.  It’s the intended effect for the Fed, but the consequences are lower valuations for stocks.

Investors were ahead of the Fed.  Stocks started pulling back in January 2022, two months ahead of the Fed’s first-interest rate hike.

This is What Tipped Investors Off

Investors knew the rate hikes were coming as yields on the Ten-Year Treasury ($TNX) were heading higher.  In January 2022, we saw the ($TNX) break above its one-year range, indicating that the market was now preparing for higher rates.

Fast forward to today… the yield on the Ten-Year Treasury is preparing to make a similar breakout higher.

The spike in $TNX from two weeks ago challenged the 2024 highs before falling back slightly this week.  That’s your indication that the bond market is preparing for higher rates.

Here’s the Number You Watch 

A move above 47.50 in the $TNX is going to start putting the market on the defensive, it’s just that simple.

Jerome Powell and the Fed are set to hold interest rates level today and likely make comments that the economy is showing more signs that we may be heading towards another fight with inflation.

Tariffs, lower taxes and deficits will be the key words from the FOMC Chairman’s announcement and press conference, none of which the market has truly prices into stocks.

That spike in the $TNX will continue a ripple effect that started last month, consumers tightening their spending.

2. Consumers Tightening is a Bad Sign

This morning’s housing news is no surprise.

Potential buyers have all but given up on home purchases as interest rates on the average 30-year home loan remain stuck at 7.02%.  

Applications for a home mortgages fell 0.4% from one week earlier and are now 7% lower than one year ago.

Applications for refinances dropped 7% from last week.

This, even though interest rates are still lower than the same time last year.

This is important because it is screaming that potential homebuyers are now backing away from the housing market for more reasons than just high rates.

Sure, housing prices inched up in 2024 due to continued limits on housing inventory, but there’s another figure above that matters.

Refinances are lower.  Homeowners are less likely to take an equity loan out on their house with rates lower than last year.  

The housing market is a cash cow for the economy.

The purchase of a home – whether it’s the first-time purchase or n existing homeowner purchasing another home – is one of the best contributor to the economy.  The home is the first of a series of large purchases, each of which will help to stimulate the economy.

Here’s the Second Thing to Watch….

The S&P Homebuilders ETF (XHB) is your best proxy of the health of more than the housing market.

This ETF includes retailers that benefit from the spending associated with a home.  Home Depot (HD), Lowes (LOW), even William & Sonoma (WSM) are all held by this ETF, giving investors a great representation of the activity associated with the housing market.

So, what does the Homebuilders ETF say about the economy right now?  It’s not great.

XHB shares are trading below their November highs, currently sitting on the brink of moving into a long-term bear market trend.

Two weeks ago, the XHB shares rallied from their recent lows, just above $100.  Remember that price.

Shares got a boost from recent earnings reports from a few homebuilders but are quickly losing that shot in the arm as they prepare to re-test what will be the most critical price since January 2022.

In January 2022, the XHB shares broke below their 20-month moving average.  This trendline acts as the indicator of a long-term bull or bear market.  

The move below its 20-month moving average sparked a bear market in housing, and the rest of the market, that drove prices another 25% lower.

Today, the price that represents that 20-month moving average is none other than $100.

The Homebuilder ETF has the added pressure of its short-term trendlines working against it.

The chart below displays the daily price activity of the XHB along with its 50- and 200-day moving averages.  Note that the ETF is trading below both of this key trendlines, suggesting that investor sentiment has turned against the ETF.

Number to Watch on the Homebuilding ETF: $100

The additional pressure of those trendlines will push the XHB back to a test of $100, followed by a shift into a long-term bear market for Homebuilders.

That move will serve as a broader warning to investors that the market is set to feel the pain of potentially higher interest rates along with a breakdown in one of the market’s leading sectors.

Here’s How to Prepare for a Breakdown in the Homebuilders and the Market

Step One: Identify Where to Take Your Profits and Set Stops

Caution and preparation are the name of the game here.

The first step that investors should consider is to identify positions that they would like to trim ahead of a potential 20%+ drop in stocks.  

Large Cap technology and other highly valued names are usually the best to target for profit-taking ahead of a bear market.

High flying stocks like the Magnificent Seven names and other large cap technology will see larger losses.  The Nasdaq 100 Index (QQQ) dropped 35% in 2022 after the Homebuilder ETF started its decline into a bear market.

Losses in the Nasdaq 100 are typically larger given these stocks’ higher price volatility and the fact that these names are much more widely held by investors and institutions.

Wise investors will identify stop prices as a way of identifying when the time is right to cut exposure to these stocks.  Be tactical and deliberate instead of simply selling everything at once.  Many investors have sold stocks too early only to see the market move higher.

Do not rely on emotions to make your decisions, always move forward with a plan.

Step Two: Identify When to Get Back In

The best profit-taking plan can be ruined by not having a plan to get back into the stocks you sold or other positions.

I’ve run into many investors that were proud of getting out of the holding ahead of a major bear market move only to be disappointed by not having gotten into the market when their stocks were down 20% or more.

They’re right to be disappointed, they missed the opportunity to increase their portfolio returns by multiples by simply identifying the price that they would repurchase their stocks.

Remember, you’re not trying to time the market, just miss part of a very large move against your portfolio.  If your stocks have moved down 20% or a predetermined amount simply buy them back.

So what if they go lower, you saved 20% or more which will compound your returns when things move back into a bull market.

Keep it simple, set a price that you want to buy every stock, ETF or mutual fund that you sell when you sell them, then do it!

Any investor can and will outperform the markets over the lang run regardless of its volatility using this extremely simple method.

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