Climbing the Wall of Worry

05/28/2009 9:25 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says doubt about the market and continued bearishness are typical of the early stages of a new bull market.

Stocks often climb a “wall of worry,” especially at the beginning of a new bull market. During these “recovery” periods, the major newspapers and financial press continue to focus on the negatives, and anxiety and uncertainty remain high amongst investors.

Understandably, investors are nervous and rightfully so. But the stock market is a discounting mechanism. It anticipates future events and reacts usually well ahead of the general public and the financial press.

During the early stages of bull markets, many investors will remain on the sidelines. They have a preconceived idea of where the market will go and will cite any number of economic concerns, as well as the warnings of CNBC pundits, to support their bearish case.

But if history is any guide, the great majority of investors who were badly mauled during the bear market will not commit even a portion of their capital until it is much too late. As Martin Zweig states in his book, Winning on Wall Street, “As the bull market proceeds and the rally fails to give way to a major decline, many investors find themselves shut out. Slowly they begin to believe that the move might be for real, and the thinking is, ‘I’ll buy on the next decline.’

“The problem is that the declines are never large enough to make people feel comfortable about buying. That’s because there are too many bears on the sidelines eager to get in.”

The obvious question is: Have we just completed another rally within an ongoing bear market, or are we now in the early stages of a bull market that has risen phoenix-like from the March lows? The rally has been most impressive. Since the March 9th lows through May 8th, the benchmark Standard & Poor’s 500 index surged 37.4%—a spectacular move in only ten weeks.

When the rally started, the S&P 500 was 49.5% under its 200-day moving average. As this is written, it is 6.2% under its 200-day line. The four previous rallies of 12%, 7.4%, 18%, and 24% all ended in failure.

Many analysts contend that the market has gotten ahead of itself and at the very least there will be a subsequent test of the March lows. We just don’t know. We are encouraged that the advance/decline ratio flashed a rare Buy signal, and thus far the market is performing exactly as it has after previous signals going all the way back to 1949; however, our long-term models, although greatly improved, have not given an all-clear.

Thus, we feel that the best course of action at this time is a partial commitment with our stop-loss strategy firmly in place.

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