Tuesday, May 5, 2009

Bear Market Rally Or New Bull?

Since the equity markets bottomed on March 9, I have always been very careful to point out that the current rally is a bear market rally.  In other words, when all is said and done, I believe that the current intermediate uptrend will be viewed as counter trend rally within an ongoing bear market.  It has been my expectation that the current intermediate up trend has a high likelihood of rolling over in the next couple of weeks.

With the market's recent lift, I have received several emails asking me: when will I throw in the towel and call this a new bull market?

Traditionally, many define bull and bear markets as a percentage gain or loss from a certain point.  For example, a 20% gain from the bottom would be a new bull market.  By this measure over the past 12 months, we have had 2 bear markets and 2 bull markets when considering the price action in the S&P500.  This is kind of silly, and for my purpose, this is not a particularly useful metric.  Then again embracing the "traditions" of Wall Street is not the way to make money.

So how will I define a new bull market?  In other words, when will I give up on this bear market rally nonsense, declare the bear is dead and start embracing the "bull" and this rally?

Let me take you through my process of how I would define a new bull market.  From a technical perspective, I like to see the market get into a "position" that has the potential to launch a new bull market.  In other words, the "next big thing" indicator has to cycle into position or the price action has to consolidate into a narrow trading range.

Why do I want this to happen? Because from 1927 to the present, every major move but one in the Dow Jones Industrial Index has seen 1 of 2 things occur from a price perspective: 1) the "next big thing" indicator cycles into the alert zone where there is a high likelihood of new secular trend occurring; or 2) prices went through a prolong consolidation period before heading higher.  This can be seen in the next series of figures, which show every major market bottom in the $DJIA going back to 1927.  The "next big thing" indicator is in the middle panel, and the indicator in the lower panel looks for statistically relevant consolidation in prices.  These are the launching pads to a new bull market.  There has been only exception and this was the 1963 bottom.

Figure 1. DJIA/ monthly

Figure 2. DJIA/ monthly

Figure 3. DJIA/ monthly

Figure 4. DJIA/ monthly

Figure 5. DJIA/ monthly

Figure 6. DJIA/ monthly

Figure 7. DJIA/ monthly

Don't like the Dow?  So let's look at the S&P500 going back to 1970.

Figure 8. S&P500/ monthly

Figure 9. S&P500/ monthly

Figure 10. S&P500/ monthly

This is pretty consistent stuff across multiple asset classes (although I have only shown equities here), and all I am trying to do is identify the potential for a secular trend change in an asset.  These indicators don't identify market bottoms.  They identify the possibility for secular trend change, and being with the longer term trend is very, very important to success in the markets.  

So once I identify an asset about to undergo a secular trend change, then I look for technical patterns to enter into that market, and these could be as simple as a monthly close over the simple 10 month moving average.  I did allude to several "set ups" in these two articles: 1) "4 Sectors That Could Be The Next Bull Market Leaders" ; and 2)  "Add These 2 Sectors To Your Watchlist"

So Why No Bull Market?
Neither the Dow Industrials, S&P500, NASDAQ, or NASDAQ 100 is in a position to undergo a secular trend change. They are close but still it is no cigar.  On the other hand, the Russell 2000 has entered that potential zone last month, and this can be seen in figure 11. 

Figure 11. $RUT.X/ monthly

So this is my first concern about the current rally.  The markets just aren't ready for a new up trend. This is not the launching pad for a new bull market.

My second reason for not making the bull market call has to do with the structure of the price action itself.  In most instances of a market bottom, I can find a prior pivot point that has acted as resistance, and prices will trade below and then above this key level thus confirming the turn in the market from bear to bull.  Or there is a close above a down trend line formed by two prior pivot points.  The monthly chart of the AMEX Airline Index (figure 12, symbol: $XAL.X), which I highlighted several times this past month,  is an example of a close above a prior pivot low point and above a down sloping trend line. 

Figure 12. $XAL.X/ monthly 

Since the market top in October, 2007, the price action has been more of unraveling than a stair step down. Essentially, there are no pivot points from which I can gauge the current price action.  See figure 13 a monthly chart of the S&P500.  All I can say about the last three months is that it is looking very "V" like.

Figure 13. S&P500/ monthly

I have provided you with two criteria that I would like to see before I make "the call" that we are in a new bull market.  Presently, these conditions have not been met, so in my book, this is still a bear market rally.  

Yet I know that Mr. Market doesn't usually consult with me, and I am well aware that a bull market can start without my criteria being met.  The market seems to have a way of spoiling the best of plans.  So I still must be prepared for the possibility that my indicators and tools just aren't sensitive enough to detect a new bull market.

If this turns out to be the case, then I would "throw in the towel" if the S&P500 closed about its simple 10 month moving average on an end of month closing basis.  Mebane Faber, from the World Beta Blog, has presented a very simple (yet effective) timing system that utilizes the simple 10 month moving average.  If the S&P500 were to keep rising and print a monthly close above its simple 10 month moving average, then I would call this a new bull market.  I will also point out that no major index has yet to end the month above its simple 10 month moving average.  

Until then, I still believe we are in a bear market.  Until my indicators give the signal, I still don't believe the potential for a new bull market exists.  The possibililty of a new bull market is always present, but the probality at this point in time seems rather remote.


Unknown said...

Thanks for laying out your case, but I could use a bit of clarification. Using the 1st chart the 2002 point is an obvious move in your NBT indicator, but the 2006 indication is not as clear(?). The 1995 indication is based on a "statistically relevant consolidation in prices", but there seems to be other similar indications that don't create the same indication. Could you help me understand this a little better?

Guy M. Lerner said...


The purple line on the graphs is a measure of how compressed prices are; it doesn't tell you which way the market is going to go; we only know that as the consolidation period is unwound prices should move rather significantly in either direction---we just don't know the direction. We know a move is coming, but we don't know in which direction. But many bull runs particularly the second leg up start with prices moving out of a base.

The "next big thing" indicator will identify the potential for a secular trend change; with this indicator when it gets to the top of its range -in that alert zone-- we kind of know that it will be a buy signal because prices have been down (y axis) for a long time (x axis); of note, there are many sectors that have been in that zone --EWJ, XLF, IYR - for over 6 months and they have continued to fall; on the other hand, there has been very little in the way of a technical set up to enter into these vehicles (XLF, IYR) other than being very very oversold.

Guy M. Lerner said...


Here is another way to think about the NBT indicator....ask yourself the question: which assets do I want to be investing in right now for the next 2-3 years?

That is what this indicator attempts to answer

Unknown said...

Thanks Guy,
I'm just attempting to understand how to intrepret your chart. I think I understand the concept behind the indicator, but I'm fuzzy on looking at your chart and intrepreting it myself.
Do you think your "smart money" never entering the rally is confirmation of your bear mkt rally thesis?

Guy M. Lerner said...

I don't follow your question on the smart money? But for the most part, the longer term secular stuff we have been talking about here is a little different than the shorter term (weeks to months) stuff of the smart and dumb money.

The longer term secular stuff has nothing to do with market sentiment; once again I am just trying to identify what assets I want to be in for the next 24 to 36 months. Then I use technicals to get me in.

For example, I would not be long bonds but I would be long bond yields based upon my work. I have pointed out several sectors that have done very well and several stocks (CERN and CSCO and BRCM) that appear to be gaining those secular winds at their back. I also stated that these would be for the next bull run because it is my belief that there will be a significant pull back in here as the price cycle or cycle of fear and greed has not been repealed.

If this is truly a bull market (and I have my doubts), then we should have 2-3 years to be making money. The CSCO's and BRCM will be there in 3 months and will look even better than they do now.

In the article (above) both conditions (potential for a secular trend change and price action per my methodology have not been met).

Unknown said...

You used your secular trend change work to support your thesis that this is a bear market rally. From a different perspective you have also noted your "smart money" indicator for the short term never showed the smart money buying into this rally. Therefore, my question is simply, does this lack of buying confirm (in the short term) your secular trend change work suggesting the rally is a bear market rally?

dacian said...


I followed Guy's smart/dumb indicator and I understood that quite differently; back in March, smart money became more bullish (you can search the blog yourself) and we had higher prices. But the last time Gary produced his indicator, both smart and dumb money were neutral which in theory means lower prices. On the other hand, it doesn't mean smart money can't be wrong.

This is how I understood the last "sentiment" post from Guy.

I hope this helps a bit :)

Guy M. Lerner said...


The last sentiment post and maybe last 4 or 5 sentiment posts have always pinpointed one thing: with investor sentiment neutral and prices below their 40 wk ma the likely scenario would be that the market's would rollover; this was the high odds play; I looked at some data the other nite and still this was the high odds play.

You are right that sentiment doesn't always get it right! We can look at data going back to 1969 with the Investors Intelligence data and for much of the 1970's it was so so....

Unknown said...

Richard Donchian, Rule number 1, first published in 1934:

"1. Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move."

So many pros have said we will have another market bottom, everyone is holding their breath waiting for it. I think this is what is delaying the move.

Marc Faber (as of late April) seems to think the low is in, and while we may have a pullback, it won't go below the march low.

In the meantime, I am playing with commodities and other asset classes while I wait for a more reasonable entry point. Perhaps I am wrong, but I am treating the current rally with suspicion.

biscosc said...

Hi Guy,

I'm curious if you have done any work on specific Rydex sector asset amounts? I've seen people taking some of the more speculative Rydex sectors and tracking the amount of money in them. For example, the Rydex Internet fund now has 137 million in assets, which is by far the highest amount ever.

Guy M. Lerner said...


I will update the Rydex data this weekend, and try to put something together for you and the readers; as you know, I have my reservations regarding the Rydex data; my sense is the sectors funds are better to gauge investor interest in a particular sector - i.e., where the hot money is flowing.

Lastly, these things have a tendency to change just as the market changes its trend. For example, what use to work no longer works. (As an aside, I am always more comfortable with something that works in multiple markets, asset classes, and through different market environments.)

Anonymous said...

Can you explain in a little more detail how the ''Next Big Thing'' curve is calculatred and at what point you read it as a signal?