Last week, running a Hidden Markov Model (HMM) on the S&P 500 Index indicated that everyone’s favorite U.S. stock market index slipped over to the dark side. To be precise, at the close of trading on December 17th, the HMM probability estimate that a bear regime had started ticked above the 50% mark.
S&P 500 Bear Market Probability Estimates
The methodology is based on modeling rolling one-year returns for the S&P on two fronts. The first is a slower but more reliable framework for using monthly data (updated daily for the current month). The second application uses daily numbers, which is faster to react to trends but more vulnerable to noise. Taking the average of the two on a daily basis provides a relatively robust estimate that attempts to find the sweet spot between timeliness and reliability.
Yes, all the usual caveats apply. Let’s also recognize that there are more than a few ways to define bear markets and HMM analytics are hardly on everyone’s short list. On the other hand, HMM modeling offers a relatively objective way to determine if bulls or bears are running the show. Based on numbers through Friday, December 21st, there’s a strong econometric case for arguing that the jig is up.
With the S&P down an additional 2.3% today — Christmas eve — it’s a safe bet that the HMM bear-market warning is set to strengthen by the close.
That’s no way to kick off the Christmas holiday. Bah-humbug, Mr. Market.