By Michael Kahn | 7 August 2008
Given weak technicals, the durability of the bear-market rally is now in question.
Investors often ask how we can tell the difference between a bull market and a rally in a bear market. Charting experts will argue many points from choppiness in price action to limited participation in the rally by various key sectors of the market. I argue that it is all of the above. This confirms that the current rally is of the bear-market variety. And while it can move higher in its current condition, its days are already starting to become numbered.
The phrase "fits and starts" is a good one to apply to today's market. Each time traditional technical signals fire off short-term buys, the following few days are spent declining. Joy turns to gloom, and then, when it seems really dark, the market kicks into high gear for a super day or two of gains. Followers of Elliott Wave analysis are familiar with the term "impulse wave," which is just a strong price move in the direction of the major trend. It is marked by strong momentum and heavy volume as investors act with conviction. Even in a bear market, investors can sell with conviction— heavy volume and urgency to trade— to create downside impulses.
In contrast, corrections are marked by lower activity and technical indicators that do not confirm the action. For a bear market, the correction is, of course, to the upside. And we should see diminishing volume as the fuel for the rally— bottom-fishers scooping up cheap stocks and short-sellers covering their bets— is used up.
That is what is happening in the current marketplace.
Price action since the July low has certainly not been in a strong trend by any definition. A market in a strong bullish trend does not take two steps forward and one step back to allow weak bulls to buy comfortably at what are seen as reasonable prices. Strong markets take five or 10 steps forward, and that can leave the timid in the dust. A chart of the Dow Jones Industrial Average during its last uncontested bull run in late 2006 into early 2007 bears this out (see Chart 1). This was a period in which pundits were talking about the lack of a meaningful correction of 10% or more, as well as a dearth of even 2% pullbacks. Clearly, if one wanted to buy stocks, it had to be on the belief that buying high and selling higher was the correct strategy.
Chart 1
Contrast that to the rally of March-May 2008 (see Chart 2). Even though there were plenty of gains to be made over the course of the move, there were ample opportunities to "buy low." The market was choppy with falling volume and modest momentum, at best.
Chart 2
This is what we are seeing in the current rally. And as mentioned here last week, the pattern it is forming appears to be what chart watchers call a "rising wedge" (see Getting Technical, "The Bear-Market Rally Isn't Over," July 30). This name is nothing more than a description of what the pattern looks like, and the golfers out there may consider it to be shaped like a pitching wedge. Now that we've given the subjective concept of "bear-market rally" a more objective definition, the next question is: How long can this rally last?
Grizzled chart watchers know that forecasting price and time targets together is usually an exercise in futility. What I can say is that my maximum Standard & Poor's 500 target, as mentioned here last week, is 1350. And as far as a time frame is concerned, I've written here in Augusts past that this month is often a time that the market decides to change its stripes. It seems that when nobody is watching, thanks to the summer holiday and lack of corporate news, the market likes to either reverse course or accelerate the trend it is already in. For the current market, that suggests that the bear-market rally should end later this month.
On the other hand, if the market is moving from bear-market rally into a full-fledged bull market, we should see a noticeable change in buying urgency with trading volume and price momentum accelerating to the upside.
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Normxxx
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