Two Sectors Will Tell Fate of this Bear Market Rally

by special guest columnist Anthony Jasansky, P. Eng.

In my last PROFIT CONFIDENTIAL commentary, I described a simple methodology of calculating the likely level of stock market reactions (retracements) to preceding price changes. I had noted that, with the exception of the Canadian TSX Composite, all other North American stock indices had yet to retrace 38.2% of their 2007 to March 2009 losses.

That percentage (38.2%) is considered a normal retracement of the preceding market move. A 38.2% retracement is viewed as a temporary counter trend within a dominant trend. In this case, the dominant trend is the bear market that started for most stock market indices in the third quarter of 2007.

The rally in the Russell 2000, an index composed of secondary stocks that racked up a gain of nearly 60% from the March 2009 lows, has also stalled at the 38.2% retracement of the 2007-2009 decline. The same applies to the NASDAQ Composite, the NASDAQ 100, the Dow Jones Transportation, and the S&P Mid-Cap indices.

Not all major indices have retraced 38.2% of their losses from their March 2009 lows. The laggards include indices heavily weighted by large capitalization stocks and financial stocks, such as the Dow Jones Industrials, S&P 500, and the NYSE Composite. By this technical measure, it is still premature to declare the rebound from the deeply oversold level of March 2009 as a new bull market.

Another indicator that has proven useful in keeping investors on the right side of the primary market trend is the price oscillator based on the difference between 10-week and 39-week exponential moving averages. While this indicator remains in a bearish mode for the blue-chip indices such as the NYSE Composite, it has just turned borderline bullish for the indices that have led the rebound from the March 2009 lows. That includes the NASDAQ Composite.

Though the overall standing of the technical group of indicators has improved, there are some areas of market breadth and trading volumes of concern. In my last column, I commented on the anomaly of just a miniscule number of stocks making new weekly highs even after the 40% to 60% gain in market indices.

The second anomaly, in what many analysts regard as a new bull market, is diminishing volume accompanying the rally from the March 2009 lows. More typically, rising trading volume accompanies the initial “blast off” of new bull markets.

Another warning is the lagging performance of two sectors that have been at the epicenter of the historical meltdown of global economies and markets, namely the U.S. banking and housing sectors. The nine-weeks-long, “dead cat bounce” in the ETF of banking stocks from the March 2009 lows has been accompanied by declining volume.

Likewise, over the last seven weeks, the Philadelphia housing index (HGX) gave back 50% of its 84% rally from the March 2009 lows. HGX topped well ahead of the general market in July 2005. By the time the leading market indices made their all-time highs, in late 2007, HGX was already down by 50%. It was a loud and clear danger signal for a sector that pumped-up and inevitably punctured the speculative bubble in the financial sector and eventually played a big role in sinking the global economy.

It will take more than a reduced rate of deterioration in these two sectors and the economy to sustain a new multi-year bull market. In the coming weeks and months, these two securities merit watching for any signs of a lasting revival.