The Market May Be Bottoming Out

06/05/2008 12:00 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says we’re not in a new bull market yet, but there are signs the major indexes have put in a bottom.

Is the bottom in place?

We can’t rule it out. In recent weeks, many of the widely followed indices have taken a step in the right direction. For example, when the Standard & Poor’s 500 and Wilshire 5000 recorded initial lows for the year back on January 22nd, almost half of the stocks that make up the Wilshire 5000 hit 52-week lows on that day.

The subsequent retest came in mid-March, when the S&P 500 dropped below its January lows on a closing basis. However, the percentage of stocks in the Wilshire 5000 recording 52-week lows was a little over 1,400 versus over 2,400 in January and since that time, the number of new lows has contracted dramatically.

Another bullish factor is the massive short-interest on the New York Stock Exchange. The short-interest ratio, bumping up against ten, is fractionally away from a multiyear high. Ten represents the number of days, based on average volume, it would take to cover existing short positions. The short-interest ratio on the Nasdaq has dropped from 4.9 in April to a current reading of 4.7. That’s still not too far away from a multiyear high and bullish for the market.

On the negative side, the chart of the advance/decline line consisting of common stocks only has traced out a pattern of descending peaks and valleys since June of last year, while advance/decline volume has traced out a similar pattern. On top of this, the lower volume in recent sessions is a sign that the market lacks conviction. This is typical of a bear market. During the previous bull market, the advance/decline line worked its way aggressively higher tracing out a textbook pattern of ascending tops and bottoms.

The market is almost one month into the [year’s] unfavorable period, which has another five months to run: It begins on May 1st and runs through October 31st. But in the early stages of the last bull market, our models flashed a major buy signal on April 8th, 2003, which was only 15 trading sessions prior to the beginning of the unfavorable period. By the time the unfavorable period ended on October 31st, the S&P 500 had tacked on a gain of 19%, while the Russell 2000 and Nasdaq Composite were ahead 40% and 39%. So, although we have now entered the unfavorable period, there are no guarantees.

How long do we expect to be on the sidelines? If the market continues to hold its own in this environment, we envision moving back into a 100% equity position within the next several weeks. We still do not see the necessary foundation that will lead to an extended bull market, although the market has appeared to have successfully tested its January lows. This is the time for patience.

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