10 Necessary Ingredients for a New Bull Market

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Includes: DIA, SPY
by: John Henderson

Since the November lows, we have been inundated with various declarations of an end to this bear market. While admirable, most of these “the bottom is in” calls seem to have been predicated on the heightened levels of fear that were seen in the $VIX in late November. With this week’s break to new lows, it seems obvious that we will need to see additional factors come into play before this bear market is officially over. In this article, I have compiled a list of these factors that we will need to see before a new bull market can begin in either late 2009 or 2010. While no list is foolproof, the various indicators and market metrics listed below have helped me in the past determine when a genuine bull market will begin and should help us to spot the end to this current bear and the beginning of a new bull cycle.

RECIPE FOR A NEW BULL MARKET

1. FRESH LEADERSHIP: Fresh leadership from companies with exciting new products and technologies is essential for a new bull market. Currently, no new leadership has yet to emerge. Worse, none is in sight. Leadership tends to come from industry sectors that were NOT the leaders in the most recent bull market. Sectors that may fill this current void in leadership include Biometrics, Gold & Gold Miners, Nanotech, Semiconductors and Software.

2. CREDIT MARKET SPREADS: The Ted Spread, the difference between the yield on the London Interbank Rate and the 3-month Treasury, needs to fall below 0.75. An elevated Ted Spread has been a harbinger of large moves lower in the equity markets. The Ted Spread gave an ominous warning to the equity markets in the summer of 2007, when it quickly doubled to a reading over 2.

A break back to more historic levels should coincide with economic activity resuming and lead to higher stock prices.

3. VOLUME: A look at the volume in the markets at the end of the 1973-1974 market is instructive. As the price action bottomed at the end of the 1973-1974 Bear Market, trading volume soared 50% on the days the market raced higher. Currently, supply is vastly outstripping demand for equities. This trend will need to reverse before a new bull cycle can emerge.

4. BUYING STAMPEDE: All bull markets begin with a Buying Stampede, during which investors scramble back into equities to ensure they do not miss the beginning of “The Move.” Elements of the stampede include the occurrence of two 9-to-1 Up Days, where 90% of stocks on the NYSE rise in price; a breakout in the NYSE Advance/Decline Line; and a surge in the number of stocks making New Highs vs. New Lows across all the indices.

5. INDUSTRY GROUPS: The ratio of Industry Stock Groups with favorable chart patterns will need to improve dramatically against those with poor patterns. Currently, most stocks are well below key long-term indicators like the 50, 150 and 200-day simple moving averages (SMA). This trend needs to reverse.

6. TIME: My research has shown that the average bear market lasts 19 months. The current bear market has just entered its 17th month. Considering that this is not your average bear market, the market will need another 3-6 months, at minimum, before we can reach equilibrium and a bottom. However, keep in mind, the shortest bear market lasted only three months (July – October 1990), while the longest bear continued for 37 months (1946 – 1949). The lesson here is that averages make for handy statistical reference points but do not get caught using them as your optimal timing device.

7. LOWER ESTIMATES: Analysts’ earnings estimates have declined with the market but they are still too high. The estimates need to drop even further. Lower estimates will result in lower market expectations which, eventually, will help stocks move higher as companies beat the revised numbers.

8. INSIDER ACTION: Previous bull markets have begun after company insiders purchased large positions in their fallen shares. There has been some insider buying in the current bear market, but not to the degree I would like to see to signal a market inflection point. After all, if insiders cannot find value in their shares during a depressed market environment, why should you?

9. VOLATILITY: S&P volatility, as represented by the CBOE Volatility Index ($VIX), needs to pull back into the 20s and high teens. Note how the $VIX moved into a new trading range as the market began its topping process in the Summer/Fall of 2007. The $VIX reached an extreme high of 80 during the recent market lows in November, 2008.

A move to lower sustained levels of volatility will induce money off the sidelines and help equities move higher.

10. SHORT RALLIES TO FADE: This bear market has been punctuated by huge short-covering rallies where the indices have been temporarily buoyed by shorts purchasing stocks to take their profits. These rallies have all failed. Remember, do not be swayed by those calling bottom after bottom, such 200-400 point moves to the upside only occur in bear markets. For the market to regain its footing, these short-covering rallies need to fade away.