Is the Bull still Alive?

Published On: 20 May 2020 | 5:00 PM

Tan Kean Soon, CFD Dealer

Kean Soon graduated from National University of Singapore with Bachelor’s Degree in Materials Engineering. He is a passionate CFD dealer who believes that equity markets can help grow one’s wealth with the right mindset, risk management & discipline.

In his free time, he enjoys learning and experimenting with long-term investment and short-term trading ideas as well as following the latest market news to get in touch with market reality.

Have you ever wondered why an up-trending market is called a “Bull” market whereas a down trending market is called a “Bear” market? This is because when a bull strikes, it will first lower its head before swinging its horns upwards, thus when the market has an upward trend, we call it a “bull” market. On the other hand, when a bear strikes, its paws are raised high and swung downwards, so when the market experiences a downward trend, we call it a “bear” market.

History has shown that the stock market is a place where fluctuating trends are observed. Bull market comes after the bear market and vice versa, a natural process that takes place in the stock market.

According to research done by Robert Miner [1], he found that in the past 120 years, the Dow Jones Index experienced bear market 15 times (in technical terms, bear market begins when an index falls at least 20% from the peak). He discovered that every bear market has 3 stages. First, the index tumbles fast by more than 20%, followed by V-shaped recovery or U-shaped recovery (however, it will not reach the previous peak level) before it tumbles again, usually to a much lower level than the initial stage.

Figure 1: Three typical stages of a bear market

The theory as to why the bear market has 3 stages is summarised as follows:

In the first stage, new black swan events trigger massive selloff out of fear. However, there are hopeful investors who continue holding onto their shares. As a result, the stock market tumbles to a certain point and enters stage 2.

In stage 2, market participants find the stock market undervalued and subsequently the demand for stocks increases, leading to a V-shaped or U-shaped rally, which then bringing about opportunity for investors who previously trapped in Stage 1 to sell off their shares. The stock market tumbles again as a result and triggers the next stage. When that happens, the rally in stage 2 becomes a “dead cat bounce”.

In stage 3, the selling wave continues like an avalanche, reducing confidence and diminishing hopes held by investors.

Of course, historical trends serve only as a good reference for our learning and gives a gauge on future market performance.

So, what stage are we at now after the recent stock market crash? To answer this question, allow us to first examine the Dow Jones Industrial Average (DJIA) and Straits Times Index (STI) index charts below.

Based on the current trend that we are seeing, we can expect similar relief packages to be announced in the next few months if the economy continues to be dampened by the COVID-19 outbreak.

Since unlimited QE was announced, both DJIA and STI indices were unaffected by this negative piece of news and saw recovery despite the release of IMF’s a report predicting a -6% contraction in global GDP (the worst recession since the Great Depression and worse than the Financial Crisis) [4], plunge in US oil prices to below zero for first time in history [5] and the rise in US’ COVID-19 cases to a million (as of 28 Apr 2020). [6]

Figure 4: Institute for Supply Management Purchasing Managers’ Index (ISM PMI) bar chart [7]

In addition, the recent ISM PMI chart shows that May 2020 PMI was in sharp decline. The PMI was derived from a monthly survey sent to supply chain managers in the US based on five major survey areas: new orders, inventory levels, production, supplier deliveries, and employment. The strong PMI downtrend suggests that the US economy will be severely affected in the coming months Yet, both DJIA and STI indices did not tumble in tandem with the PMI. This could be due to on-going strong fiscal support from both the US congress and the Fed to the US economy and the stock market.

Hence, in the short term, the stock market will most likely be poised towards its path of recovery. However, should there be another Black Swan event (outside of both COVID-19 and oil prices), there is a chance the stock market would crash again and trigger the Stage 3 bear market as the stock market fears uncertainty.

Example 1: Equities CFD on Shares

Examples 2 – Straits Times Index SGD 5 CFD

On 04 May 2020, STI index was at 2500.

In Straits Times Index SGD 5 CFD contract, each STI point is worth SGD 5.

Initial capital commitment for holding one Straits Times Index SGD 5 CFD contract
= 2500 x SGD5 x 6% x 1 = SGD750

On 05 May 2020, STI index rose 2% to 2550.
^Gross Profit = (2550 – 2500) x SGD5 x 1 = SGD250
^Return of Investment (ROI) = $250 / $750 = 33.3%

This means for every 2% gain in index point, you earn 33.3% of your original investment capital (16.7x leverage).

Although CFDs can magnify your gains through leverage, losses are also magnified and you could lose more than the original investment committed when the market or index point goes against you. The key is always to use leverage responsibly and cut losses quickly when the market turns against you.

* Calculation here omits commission, clearing fees and all other trading fees in shares trading. Actual ROI will be lower than the ROI mentioned in the examples above.

^ Calculation here omits commission and finance charge for CFD trading. Actual ROI will be lower than the ROI mentioned in the examples above.

References:

[1] PDF: DT Big Picture Update – Stock Indexes: Part 2 – March 28, 2020

[2] https://www.bloomberg.com/quote/INDU:IND

[3] https://www.bloomberg.com/quote/STI:IND

[4] https://www.imf.org/en/News/Articles/2020/04/14/tr041420-transcript-of-april-2020-world-economic-outlook-press-briefing

[5] https://www.straitstimes.com/business/companies-markets/us-oil-prices-plunge-below-zero-in-devastating-day-for-global-industry

[6] https://www.washingtonpost.com/politics/covid-19-cases-top-1-million-in-the-united-states-about-a-third-of-known-cases-worldwide/2020/04/28/e5fafd4e-8944-11ea-9dfd-990f9dcc71fc_story.html

[7] https://www.forexfactory.com/calendar?range=apr12.2020-may9.2020#graph=111413

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