Wednesday, January 19, 2011

Market Update

On March 6, 2009, The S&P 500 stood at a 12-year low at 666.79, with only 2% of traders bullish on the stock market. That means 98% of traders thought the market was going lower. Yet, amidst the worst recession since the great depression, with no positive fundamentals, the market started a rally that has progressed over 94% from the low to yesterday's high of 1,296.06. Now there are over 90% of traders bullish on the S&P, with an positive fundamentals, and improving economy, and, needless to say, optimism. While the stock market has risen over 90%, and most are convinced a new secular bull market started at the March 2009 low, it is still only a bear market rally within a much longer term secular bear market. The aim of bear market rallies is to convince everybody that the bear market is over. Once that happens, and enough people are convinced that a new secular bull market has started, the market reverses and the bear market resumes. There are a number of reasons I am convinced this is only a bear market rally. One is valuation measures. Whether you look at dividends, P/E ratios, or the percentage of mutual fund cash (currently at an all time record low) the market is historically over valued. In early March 2009, the P/E on the market was 23.77. This is not a reading that has coincided with previous bear market lows. In the 1932, the P/E ratio got down to 10. In 1974, the P/E ratio was 7.24, and in 1982, even with a higher low in the market, the P/E was an even better 6.9. The current P/E ratio, according to, is 23.47. When the market makes its final low for this bear market, I expect the P/E ratio to be within the range of normal bear market lows, and possibly even lower. In other words, I think there is a great buying opportunity coming up this decade, however I do not see that time as now. Another reason I think the bear market is not over is secular cycles. The stock market moves in waves of optimism and pessimism. When the market is moving in a long-term uptrend, and optimism is building, we call that a bull market, and when the market is moving in a long-term downtrend, and pessimism is building, we call that a bear market. There are two types of bull and bear markets: Cyclical and Secular. Cyclical bull and bear markets are usually multi-month or multi-year uptrends or downtrends, however they are within the context of secular bull and bear markets, and usually fool the public into thinking the long term trend has changed. For example, the crash of 1987 was a cyclical bear market, but it was in the context of the secular bull market that started in 1982. That secular bull market ended in 2000, and lasted about 18 years, although the nominal Dow did not top out in Primary Wave V (the last wave of a bull market) until 2007. Even though the stock market made a new high in 2007, it did not in real terms, as I have shown in previous posts. So while a cyclical bull market unfolded between 2002-2007, the secular bear market actually began in 2000. Before that bull market started, we were in a secular bear market from 1966-1982, 16 years, before that a secular bull market from 1949-1966, 16 years. See a pattern? Based upon various time cycles and historical bull/bear market relationships, I am expecting the stock market to make its bear market low on or close to 2016. The year 2016 would mark 16 years since the bear market began in 2000. Within the secular bear market that lasted from 1966 until 1982, there were cyclical bull markets, but they were all in the context of a long term secular bear market until the market made its final low in 1974 at Dow 570. That brings us to today, Wednesday, January 19, 2011. The market has risen from March 2009 in a bear market rally (cyclical bull market). The sentiment on Wall Street right now, in my opinion, is the complete reverse of early March 2009. This market is in for AT LEAST a correction, if not an end to the entire bear market rally. Tom Demark, a well-respected market technician on Wall Street, issued a sell signal tonight, one that has not been issued since July of 2007, saying

" U.S. stocks are within a week of “a significant market top” that is likely to precede a drop of at least 11 percent in the Standard & Poor’s 500 Index. “I’m pretty confident that in one to two weeks, the market will be in a descent,” said DeMark, founder and chief executive officer of Market Studies LLC. “It could be pretty sharp.” His words of warning are certainly justified, as the market is completing 5 waves up from July 2010, and is close to starting a new downtrend. Below are some charts I have put together. In Elliott Wave, whenever you complete five waves up, you have a 3 wave correction, as shown below. The chart below is the bullish scenario, that this is just a pullback within the ongoing bear market rally, and Wave C up will subdivide into 5 waves, with the move from July 2010 being wave one. After this we would get an A-B-C pullback in a wave 2, then waves 3, 4 and 5 to complete wave C and in turn the bear market rally.

The following chart implies that the entire bear market rally is ending now, completing a 3 wave move (A up into April 2010, B down into July 2010, and C up terminating now) from March 2009. 3-wave moves are corrective, while 5-wave moves are impulsive. Even under the bullish case, where this wave C subdivides into 5 waves, We would be entering into a wave 2 down very shortly.

(please note, the drawings on these charts are not to scale, Wave C down could go much, much lower than the terminus of the line I have drawn on this chart)

The nature and extent of the next downtrend will tell us whether this is just a pullback within the bear market rally that started in March 2009, or the resumption of the larger bear market. I will post an update in a couple of months with, hopefully, an answer to that question. I wish all reading this blog a happy and prosperous 2011.