If It Growls Like a Bear

02/05/2008 12:00 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of the Chartist, says we’re likely in an extended bear market and investors should not be seduced by misleading rallies.

Our primary reason for flashing a sell signal on January 15th was due to the breakdown in the high relative-strength stocks. It has been our experience over the years that the high relative strength stocks are the last to fall.

This was certainly the case in early January, in that the high-relative-strength stocks were doing an excellent job of resisting the downside bias of the overall market. However, over the next few trading sessions, the high relative strength stocks for the first time in this cycle began to under perform.

By January 15th, the Dow Jones Industrial Average and the Standard & Poor’s 500 index closed narrowly under their intraday lows of August 16th. It should be noted that the NASDAQ composite, S&P Midcap, Russell 2000, and Value Line Composite indexes had already taken out their August lows.

Over the years, we have found that while the high-relative-strength stocks are in most instances the last to fall, they have a tendency to catch up in a hurry, falling faster than the overall market, especially during panic selloffs.

The last time we were in a 100% cash or equivalent position was close to five years ago. It will be recalled that we exited the market on February 8, 2002 and did not return until April 8th, 2003. Over that period, the Russell 2000, S&P 500, and NASDAQ Composite index lost [roughly 20% of their value]. That is a long time to be on the sidelines, and while there were some sharp rallies over the period, the overall market as measured by the S&P 500 was in a pronounced down trend.

In our view, there is now a very high probability that a bear market is in effect. Over the last 100+ years, the average bear market has lasted over 400 days, ranging from under 50 days to close to 1,000. So if we are in a bear market, how long it will last is anybody’s guess.

A great deal of technical damage has occurred, especially to many individual issues, so much so that we feel it is not going to be repaired overnight. Many analysts found the [recent] rally to be most encouraging. Many investors are tempted to jump on board. However, if this turns out to be an extended bear market, we will witness many such turn-on-a-dime events. The snapback rally is partly based on the expectation that the Federal Reserve will be able to make everything well with its rate cuts and stimulus packages.

This is wishful thinking: remember, in the last bear market the Fed was cutting interest rates all the way down. We feel that any rally at this point will present overextended investors an opportunity to reduce their equity exposure.

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