April 11th, 2009

Bear Trap or Bottom? That Nagging Question Again.

The New York Times recently joined the debate as to whether the recent 25%+ move is Bear Market Rally, a Trap, or something more significant by trotting out three stock market experts (two were actually economists) who said:

  • “Some stock market rallies are reassuring. Others provide at least temporary respite. And a third kind, more commonly seen in emerging markets, actually expose deeper underlying problems and contribute to a further downturn.” (Simon Johnson, professor at M.I.T. Sloan School of Management, co-founder of the global crisis Web site BaselineScenario and regular contributor to the Times’s Economix blog.)
  • “There is still tremendous uncertainty about the extent of the damage to economy. We still don’t know the value of the toxic assets central to the banking crisis. Fear remains a factor, leading firms to postpone investment and hiring decisions. But we are moving past the big spike in uncertainty of last fall. And if uncertainty continues to decline, growth should start to rebound.” (Nicholas Bloom, a Stanford University economics professor and associate at the Center for Economic Performance, London School of Economics.)
  • For many investors, dollar cost averaging into broad index funds works well. If you want to be a bit aggressive, you can increase your contributions once the markets fall 30 percent or (like now) 50 percent. The time to throttle back? After a four- to seven-year bull market run.” (Barry Ritholtz, chief executive of Equity Research at Fusion IQ, author of both The Big Picture blog and a forthcoming book.)

Not very forward-thinking nor do they offer individual investors much clear, actionable advice. So I took the liberty of adding my 2¢ with the following comment:

“Few can predict the future and it’s probably a waste of time even trying. Likewise, few can distill the varied financial, economic, political and international cross currents underlying the true nature and future of the stock market’s trend.

What is evident is that the majority of investors and traders are now beginning to feel confident enough to put a continually larger portions of their cash to work in the market thereby boosting prices on an ever growing number of stocks.

It’s not significant enough yet to categorically say that a bull market has begun but one can unequivocally say that the degree of market support, as represented by buyers’ demand for stocks, hasn’t been seen since mid-2007.”

What I was referring to is improvement in the various moving average benchmarks I’ve reported on before here:

Note the following (click on table to enlarge):

  • At the Bull Market peak (highlighted in yellow as July 16, 2007), 51.7% of stocks were above their 90-day MA’s. As might be expected because they are consecutively slower and behind, consistently larger percentage of stocks were above their 180- and 300-day MA’s.
  • The last “Bear trap” Rally (marked above in yellow) or, as long-time readers recall from “Beware Suckers’ Rally“, was in March-May, 2008. Each of the MA statistics improved during that 2-month rally but none, except for the number of stocks above their 90-day MA reached the level that existed at the Bull Market Peak.
  • March 9, 2009, consider by many as the Bear Market Bottom, saw more than 80% of stocks below their 90-day MA’s and almost 95% were under the other indicators. Stocks were clearly in a free-fall downtrend.
  • But stocks have definitely rallied over the past month to April 9. More stocks are now above their 90-day MA than in both the Bear Trap of May 2008 and even the Bull Market Peak in July, 2007.
  • The other indicators, however, are still somewhat weak relative to prior periods. One of the main reasons that fewer individual stocks have now above their 180- and 300-day MA’s is the steepness of the declines. The Bear Market was just beginning, as we now know, by March-May 2008, the longer MA’s were still within grasp but even greater, steeper declines were yet to come.

Therein lies the question of whether this months 25% gain is another Bear Trap or part of a reliable Bear Market Bottom?

One way to tell is by comparing and contrasting charts. I scrolled my chart database back to June 2008 to see how many stocks then seemed to include what might have been considered reversal-type (bottom) chart patterns. What I found was that few stocks are going to make reversal patterns unless the market is in the accumulation phase. When the market is in mark-down phase, stocks form continuation patterns that end with their declines resuming.

What you see is that the March-May 2008 Bear Trap and the current market since November are similar except that, this time, the market recovered nicely after March 9 low. In 2008, the market failed to hold its March bottom and it actually accelerated its descent when that level failed as support. Many individual stocks have formed clear reversal patterns this time. I found few reversal pattern attempts in 2008.

It’s difficult putting limits on the optimist in me trying to break out but discipline demands that confirmation come through successful testing of the support. Unfortunately, we won’t know for sure whether the market remains stuck in mark-down or has actually moved into accumulation phase until it again tests the lows (o.k., you got me, that might be the same question as “trap or bottom?”).

More and more stocks will continue to form reversal patterns so that when more than 30-50% of stocks again cross above their 180- and 300-day MA’s and more generate “golden crosses”, the S&P 500 will also be able to cross above it’s 180-day MA and the end of the 2007-09 Financial Crises Bear Market Crash will finally be signaled.

My opinion may be no clearer than those experts quoted above but I feel, based on the continued improvement of individual stock charts, this time the bottom will hold and a significant upside move will be launched later in the year.

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