What You Need To Know About Bear Market Rallies

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As stocks moved higher this week there was daily commentary on one of the financial networks as to whether the market had bottomed or if the rebound from the March 14th low just a bear market rally.

A number of experts voiced their views on this very question. Some who were adamant in their opinions did not volunteer what would change their opinion. I typically disregard those opinions as in my experience the use of the terms ‘never’ or ‘always’ is not appropriate when it comes to the financial markets.

Last week I presented some of the reasons why I thought this was more than a bear market rally. The stock market gains have supported my analysis as the Nasdaq 100 was 2.3% higher and is now up 4% in March. For a change, the Dow Jones Utility Average was the star performer as it gained 3.4% last week and is showing a solid year-to-date (YTD gain of 3.4%.

The S&P 500 had another solid week as it was up 1.8% which is slightly better than the 1.7% rise in the SPDR Gold Trust (GLD) that is showing a solid gain of 6.7% YTD. Many strategists point to the impressive gains from the March 14th lows as a reason this has to be a bear market rally and not an end to the correction from the late 2021 highs.

The Invesco QQQ Trust (QQQ) is up 13.2% from the March 14th low of $317.06 but is still below the 50% retracement resistance at $363.08. The more widely watched 61.8% Fibonacci resistance is at $373.85 and a close above this level would be another sign that this was more than a bear market rally. The QQQ now has good support at $345.05 and the monthly pivot.

The Nasdaq 100 A/D line has broken its downtrend, line b, and has moved above its now rising WMA. The next important level of resistance is the early February high. The weekly A/D line is rising but still below its WMA. The volume on the rally has not been impressive which is reflected by the fact that the on-balance-volume (OBV) is still below its downtrend, line c. The weekly OBV (not shown) is positive and above its WMA.

This rally has not been quite as impressive in the Spyder Trust (SPY) as it is up 10.3% from the February 24th low of $410.64. The 50% resistance at $445.31 was overcome last month. The Friday close at $452.64 was just below the 61.8% resistance at $453.49. The February highs are at $458.12, line a. Some bearish technical analysts are watching the 4600 level in the S&P 500. The close last week was well above the 20 week EMA at $445.73. A drop below last week’s low at $440.68 would be negative on a short-term basis.

As was pointed out last week the S&P 500 A/D line closed above its WMA and rose further last week. This is a positive sign for the intermediate-term trend. The weekly NYSE Stocks Only A/D line (not shown) has also now moved above its EMA supporting the action in the S&P. A drop in the weekly S&P 500 A/D line below support (line b) would be a negative sign for the intermediate trend.

Many investors may not have been in the stock market during the bear market rally in March through May of 2008. This I would consider to be the last meaningful bear market rally. Bear market rallies are an essential part of the bull-bear stock market cycle.

In my observations, the key function of a bear market rally is to change investor sentiment, convincing them they should no longer fear a further decline. This briefly injects capital into the market, rising stock prices sufficiently enough for a wave of selling to take place, leading to further decline.

Corrections in a bull market play a similar role as the decline needs to last long enough and go low enough so that investors sell as they fear a further decline. That was certainly what happened in the last quarter of 2018 as many were convinced to sell after an almost three-month decline.

The bullish % from the weekly survey by the American Association of Individual Investors (AAII) is often quite good in tracking these changes in sentiment. On this daily chart of the S&P 500 from 2007-08 I have labeled various highs and lows with the percentage of investors that reported being bullish that week (bullish%).

By the January 23 low (point 2) only 25.4% were bullish. Over the course of the decline, bullish sentiment tends to decrease. After a 24-day, 9% rebound, the bullish% had improved to 34.3% (point 3). On the next decline, the S&P 500 made a new low during the week of March 10, and the bullish% declined to 20.4% (point 4).

From the October 11, 2007 high of 1576 to the final correction low of 1257 on March 27, 2008, the S&P 500 had a decline 20.2%. Ten days after the March 27 low, the 38.2% resistance level at 1379 was overcome.

By April 7, the S&P 500 had reached a high of 1386, and the bullish% had more than doubled from the March low as it was then 45.8%. This reading was followed by a sharp market decline and the bullish% the next week was 30.4%, but was still in an uptrend.

On May 2ndthe 50% resistance at 1417 was also overcome as the bullish% had risen to 53.3% (point 5). The next week the bullish% was also high at 52.8%. The week of the May 19 high, the bullish% had dropped to 46.3%.

On May 19, the S&P 500 had a high of 1440, just below the 61.8% retracement resistance level, and then closed at 1426. The close in the S&P 500 below the support from the March lows indicated the bear market rally was over. It had lasted 45 days.

It should be no surprise that the public’s perception of time is much shorter now so after a twenty-one-day rally from the February 24th lows some bearish analysts are starting to modify their positions. Many newsletter writers who I interviewed in February of 2008 were no longer bearish in May. By July the March 2008 lows had been violated.

The other major news last week was the parabolic in yields, especially short-term rates. The yield on the 3 Year T-Note closed at 2.51%, 10 Year at 2.48%, and the 30 Year at 2.60%. The 3 Year yield broke out above resistance at 0.3%, line c, in February 2021 has more than doubles in 2022.

The economic data was not any worse than expected last week and some manufacturing data was better. There is more economic data this week with GDP and then the monthly jobs report on Friday. The sentiment on the economy is not very optimistic and does seem to be getting worse.

An inversion of the yield curve is likely in the next week or so that would bring recession into the headlines. It may convince even more investors that a recession is unavoidable. I would wait to see the data over the next two months before coming to that conclusion.

There are still a number of buying opportunities that emerge each week but until the A/D lines start to trend higher I would not chase prices and continue to respect the risk on any new positions. Once the 61.8% resistance levels are overcome and all the weekly Advance/Decline lines turn positive I will become even more convinced that it is not a bear market rally.

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Credit: www.forbes.com /

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