Here’s How Much Higher this Bear Market Rally Will Go

Bear markets have big rallies. They tend to be short and sharp. Bull markets have long, typically slow moving uplegs.

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But there’s a problem. That’s because the first leg of a new bull market typically looks like a bear market rally. It’s hard to tell the difference when you’re in that situation, like now. But does it matter?

No. You don’t need to rush in.

So let’s take a look at where we are now, and decide if we’re still in a bull or bear market.

Wall Street Says It’s Not a Bear Market But I Say It Is Because of the Tried and True

Now, the Wall Street media will tell you that we’re still in a bull market because neither the Dow nor the S&P ever closed down 20% from the highest close. Where that silly rule came from, no one knows.

Yet the Street pundits apply it universally to both the market averages, sectors, commodities, and even individual stocks. This is despite the volatility of each varying enormously. The Dow is a low volatility index. The Nasdaq is higher volatility. The price of crude oil has very high volatility. Treasury bond prices tend to have low volatility over the longer term, but can have high volatility day to day.

Crude oil will typically move 20% over the space of a couple of months. It may take the Dow a couple of years to move that much. And some stocks may never move that much. Applying a 20% standard to call any down market a bear market is baseless. It’s also useless.

I like to use the Dow Theory standard in conjunction with long term technical indicators. The  Dow Theory says, in essence, that the stock market is in a bearish primary trend when both the Industrial Average and the Transportation Average have made lower highs and lower lows over several months.

From its intraday high of 26,952 on October 3 to its intraday low of 21,713 on December 26, the Dow lost 19.4%. To the Wall Street media crowd, that means no bear market yet. However, the broader S&P 500 dropped 20.2% from high to low. Oops! Not to worry! That doesn’t meet their bear market standard either. They claim that the measurement must be based on closing prices. On that basis, the S&P only lost 19.9%.

Phew! No bear market!

And the President had Treasury Secretary Mnuchin put on a big reality show, calling the bankers and calling in the PPT. He announced that it would be a good time to buy stocks. If you were a cynic, you might think that the fix was in, but of course our financial markets are free and fair.

OK, not. The Fed blatantly and openly manipulated the markets higher with QE for years. That’s ok. We follow the Fed, and act accordingly. Manipulated or not, the markets are tradable.

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But what about the time tested Dow Theory, formulated by the original publisher of the Wall Street Journal, Dow Jones? Charles Dow developed the theory in a series of editorials in the late 1800s. Subsequent publishers William Hamilton and Robert Rhea later named it and formalized it as the Dow Theory.

By the way, it was never meant to be a market timing signal, but rather an indicator of the prospects for the US economy. But early on it became widely accepted as the way to identify and confirm the market’s major trend.  Unlike today’s 20% “rule,” there was a clear source, some deep thinking, and valid reasons why the Dow Theory became widely accepted. That was still true until the 1980s, when I last worked on Wall Street.

The 20% rule didn’t come around until recent years when apparently a talking head on CNBC thought it would be a good idea to say it. I have communicated with some very well known fin journos through the years, and to a man and woman, not a single one of them has any idea where this “rule” came from. I have ridiculed them incessantly for calling a 20% down move an “official” bear market. By what “official” standard was that. Apparently, they heard me because in recent months they’ve come to use the term “commonly accepted view.” More accurate, but just as useless.

These two charts that show that the stock market has been in a bear market since early October. That’s when it started, although it wasn’t confirmed until December.

The Dow Theory says that if both the Industrials and Transports have made lower highs and lower lows over several months, then the primary trend is bearish. That condition was fulfilled on December 11. That’s when the Transports made their first lower low after a lower high.

 

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(Note: The white line is the 200 day average, a useful trend indicator, but not for this purpose).

The Industrials had already achieved that ignominy on November 23 based on closing prices. That was confirmed on December 14 with another lower close.

 

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Despite the current amazing rally off the low, neither the Dow, nor anything else, is remotely close to making a higher high. The most likely path to a bullish signal would be if the two averages pulled back to a higher low than the Christmas Eve massacre, and then subsequently rallied to a high above where this rally peaks. That would take a couple months. But if it happened, the likelihood  would be that we’re back in a bull market.

Until that happens, the assumption must be that we’re in a bear market.

The Dow Theory is useful for confirmation but I rely on long term technical and cyclical analysis to reach my market view. I feature the chart below in my weekly reports to subscribers. After a bearish period in 2015, it turned bullish in early 2016 when the 3-4 year cycle indicators began to reverse. As you know, I’ve been alluding to the current market as a bear market since early in 2018 when 3-4 year cycle indicators started to roll over. That signal was early as they usually are at tops, but it was confirmed in October when 3-4 year cycle momentum broke down.

That indicator is likely to be late calling the turn at the next bottom. For trading the big swings, whether a bear market rally, or the first leg of a bull market, the 10-12 month cycle indicator should give a timely signal. It hasn’t turned up yet. Historically, the market only launches a sustained rally when this indicator makes a double bottom or a higher low over a period of several weeks or months. We’re not close to a similar condition.

 

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When a market or a stock breaks down from a major top formation, or any major support level, it is normal for a rebound to follow that carries back to the area of the breakdown. In this case the target range would be 2550 to 2650. We’re in the lower portion of that now.

Another norm would be a 50% retracement of the preceding decline. That would take the rally back to around 2640. That’s also the area of an equal width channel downtrend line. Less common is a Fibonacci 38.2% retracement, which would be 2580, where the market is as of this writing.

Any of these numbers would be reasonable targets for the top of this rally. The market remains very thin. It has moved quickly and easily through this range. That could now change as the market should run into supply between 2580 and 2640. In the days ahead, I’ll be watching the shorter term indicators for signs that we’re about to roll over again.

Meanwhile you can look to our trading gurus here at Money Map Press for profitable trading ideas, regardless of the market’s direction! Here’s one.

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Sincerely,

Lee Adler

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