Can the Market’s Rally Last?

04/03/2008 12:00 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says stocks were deeply oversold before the recent run-up, but he thinks this is a bear market rally, rather than the start of a new bull.

On a technical basis, all of the major indices, with the exception of the Dow Jones Transportation Average, are [still] well under their down trending 200-day moving averages. Currently, the indices have rallied back to their 50-day moving averages, [but] thus far, all of the rallies, again with the exception of the Dow Transports, have fallen short of the previous peak.

Since early October, the benchmark Standard & Poor's 500 has had no less than six failing rallies. The Dow [Jones Industrial Average], S&P Mid Caps, Russell 2000, and Value Line Geometric have traced out similar chart patterns. This is typical bear market action.

[A recent poll] from Investors Intelligence now shows 36.7% of advisors in the bullish camp versus 41.1% bears. This marked the third week in a row in which the percentage of bears was in the majority, which is a favorable sign for the market.

Another source of sentiment is Consensus Inc., which covers hundreds of advisory services as well as brokerage house analysts. At last glance, the percentage of Consensus bulls was all the way down to 22%, the lowest level in close to six years.

It is also favorable that the short-interest ratio on the New York Stock Exchange is bumping up against 9%, a multiyear high. [And] the percentage of stocks that were still above their 200-day moving averages had fallen all the way down to 15.5% on March 10th, which was the same reading generated at the January lows. These twin readings were the lowest in several years.

The January lows represent a very formidable area of downside support. The recent [successful] test set the stage for a powerful rally that got underway on March 18th with the Dow surging 420 points. The Nasdaq [Composite index] jumped 4.19% on that day, which is the equivalent of 500 Dow points.

Powerful bear market rallies often retrace two-thirds of the previous decline. A two-thirds retracement of the ground lost between the intraday highs of 14,198 recorded on October 11, 2007 and the intraday lows of 11,634 set on January 22nd would take the Dow up to 13,343. We think this is a distinct possibility. In fact, it could go even higher. [But] many bear market rallies end up sucking in thousands of investors, convincing them that a new bull market is underway.

Could a new bull market be underway? It could, but with our models in a highly negative mode, we seriously doubt it. Before we reenter the market, we must see some strong evidence that an effective bottom is in place and on top of this, our models must turn positive. The ideal scenario for us is to move back into the market after it has already moved off its lows.

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