With regards to the recent post on key price levels, a reader emailed and asked me if I was “throwing in the towel”. I can only presume he detected a sense of bullishness in my comments. Yes, the price action has been bullish, but I am still uncomfortable calling an end to the bear market as I don’t believe this is the proper launching pad for a new bull market. I know I make a lot of noise about this launching pad stuff, but I have to ask myself this question all the time: how do we get there from here? Without the proper set up, I don’t see a new bull market happening.
But then again, why does it matter if we are in a new bull market or bear market rally? It really doesn’t matter what we call it, but all that I am trying to do is determine if we rollover or if we continue to march higher in a nice 45 degree ascent on the price chart.
As I stated in this week’s sentiment commentary, I have not resolved the issue of new bull market versus bear market rally:
My own work suggests bear market rally, but I do acknowledge that the persistence of the bulls is very reminiscent of 1995 or 2003, when sentiment got stuck in the bullish extreme while prices continued higher. As the equity indexes continue in a range, we haven’t seen the “much higher” yet to confirm the new bull market scenario. On the other hand, we haven’t seen the market break down and confirm the bear market rally scenario. We are stuck in a range, which means lack of resolution.
So how can I be bearish when the price action has been bullish? It isn’t so much that I am bearish because I really don’t have an opinion, but the sum of the data that I look at suggests that the rally should rollover within a couple of weeks. Yes, I have been stating this since early May, and it has not happened, and in my mind, I always think of the old market adage: when the market does not do what you expect, then sit up and take notice.
Several readers have emailed stating that I should change the name of the sentiment indicators. The “smart money” should now be the “dumb money” and the “dumb money” should now be the “smart money”. Of course, I should be the “dumb money” and of course, the peak of the emails were after Monday’s close and possible breakout from the range 4 week range.
Let me remind readers that the purpose of the sentiment indicators is to get in front of the potential trend changes before you have an 8% sell off in a week and you have given back a majority of your profits. In trading, it isn’t so much where we are today but where we will be in the future. Most of the time -nah, more like 85% of the time – the sentiment indicators work without remorse. In other words, I expect to be happy with my choices most of the time. On the other hand, if you want to trade or invest like it is always 1995 or 2003 when it was all bull all the time then go ahead.
So let’s contrast the sentiment analysis with the key price level analysis. The sentiment analysis attempts to define where we expect prices to be in several week’s time. So typically, there are too many bulls and too many bulls usually means lower prices ahead. With the key price level analysis, it is more after the fact as in prices closed above a key resistance level, so therefore we are now bullish. So yes, the price action has been bullish as resistance levels have fallen, but sentiment is getting very bullish, which historically isn’t a good sign.
Think about it this way: after a plus 40% run folks are now only getting bullish. The time to be bullish was 40% ago. You should salivate at lower prices and cast a skeptical eye at higher ones.
So what technical evidence would I like to see to call the end to the bear market? I discussed this in the May 5, 2009 commentary and I will summarize briefly here. My research shows that this is not the correct launching pad for the end of a bear market. Markets usually consolidate for long periods of time before heading meaningfully higher or the sell off goes on for a longer period of time. Time or the x-axis is one of the concepts of the “next big thing” indicator, and this indicator has not cycled into position yet (with the exception of the Russell 2000). Going back to the 1920′s on the Dow, every market bottom but 2 saw either a period of consolidation or the “next big thing” indicator suggest that a secular trend change is at hand.
I openly acknowledge that I could be wrong – that my indicators and use of pivot points to characterize the price action cannot detect the current “v” like bounce seen on the monthly charts. From my vantage point, this doesn’t seem likely as I utilize my indicators across multipe markets, and they have worked well in backtests over the past 50 years.
Of course, this time could be different. If this turns out to be the case and we are embarking on a new bull market, then I have back stopped myself by adapting the simple, yet elegant strategy credited to Mebane Faber. I will buy the S&P500 on a monthly close greater than its simple 10 month moving average. Now there is nothing magical about the 10 month moving average, and in fact, the 9 month simple moving average works just as well. The success of the Faber strategy isn’t the buy signal, but the selling discipline. If wrong, you know it as prices close below the simple 10 month average, and you move on. Nice and neat. Once again, the success of the Faber Model isn’t the buy signal, it is the aversion to risk.
It should be noted that a monthly close greater than the simple 10 month moving average doesn’t mean the market is entering a new bull market. A noteworthy failed signal occurred in March, 2002, and this was the top of the market that led to the flush into July, 2002. All I am saying is that the Faber Model is a “safe” and reasonable way to participate in a rising trend.
In summary, I am constructive on the price action. Yet, I still believe that this is a bear market rally. If I am wrong, that is ok and I have a plan, which I will execute. It isn’t so much where we are today that bothers me, but where we will be tomorrow. I just don’t see the market getting to that promise land just yet. But all that will be put aside when and if prices close above their simple 10 month moving average.
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