Technically Speaking: An Obituary for the 2000-2007 Bull Market

The disagreement between buyers and sellers, the bulls and the bears, is what keeps the market ticking. No matter how one-sided the bullish or bearish evidence, there will always be a notable minority of market seers and investors who will take a contrary view.

How wise and profitable the outcome from being contrary and going against the majority is depends much on the time frame that one remains on the “wrong side.” In the short term, measured in weeks and months, “the trend is your friend.” Irrespective of being long or short, trading against the dominant market trend does not pay. That is, unless one has the Midas touch in picking stocks that defy the dominant market trend.

In contrast, when it comes to measuring investment returns over several years, taking the contrary position has often turned out to be a profitable stand. The crucial task is to estimate when the primary trend gets overextended enough to warrant going against the expectations of the majority. In other words, when “everyone thinks alike, everyone is likely to be wrong” and that is the time to go against the trend. Sentiment indicators are invaluable in the timing of contrary positions.

However, when one has enough time left before his appointment with his Maker, the evidence of the last 100 years favors the long side. The steady long-term uptrend has smoothed numerous bull and bear market cycles, providing a strong argument for buying and holding. This is after all the selling mantra of the mutual funds industry.

As simple as the three time frames seem, investors typically do not give enough thought as to whether they are trading or taking long- term positions. Often a short-term speculative trade that has gone wrong becomes a long-term investment, just to avoid taking limited short-term losses. At the other extreme, selling too soon after a stock makes an unexpectedly large gain may also be ignoring the original long-term objective.

That brings me to the current market that has lost between 20% and 25%, depending which index one uses, from its late 2007 all- time highs to the January 22/08 lows. Declines of more than 20% are generally viewed as the minimum limit for bear markets. While the declines of 19.3% in the S&P 500 and 19.7% in the NYSE Composite fell short of 20%, the Russell 2000 and the NASDAQ 100 losses of 25% and 24.4% have already made the cut.

Since last November, I had noted three technical developments pointing to a bear market in the making. In my December ’07 column, I had noted the November 22/07 sell signal from the Dow Theory (DT). Subsequently, in the January 5/08 update, the DT sell signal was confirmed by the Long-Term Price Oscillator between 10- and 39-week exponential averages of the NYSE Composite. At that time, I had also said that all that was missing in order to write an obituary for the 2002-2007 bull market was the completion of a Head-and-Shoulder (H&S) top formation on the charts of major market averages. It did not take long before the S&P 500 and other broad based indices broke the neckline of their H&S tops and completed the classical H&S bear market formation.

There are definitely enough gloomy and shocking news releases, including multi-billion-dollar write-offs reported by financial companies, to trigger another large sell-off. On the positive side, the overwhelmingly bearish headlines have depressed the sentiment of professional and public investors alike to levels historically seen prior to rallies of 10% or more. However, I am apprehensive and hesitate to extend this historic precedent to the current equity market. After all, never before have investors ever faced a comparably widespread and lasting meltdown in the global credit markets.