Bear Market Rally Nearing Completion

 |  Includes: DIA, QQQ, SPY
by: Sean Hannon

In the March 9 issue of my weekly newsletter EPIC Insights, I indicated the markets were extremely oversold and preparing to rally. On that day, the Dow bottomed at 6,547 and has since rallied 17%. In the March 16 newsletter, I stated that the Dow would approach 8,000 during the current bear market rally. On March 26, the Dow closed at 7,924 and traded as high as 7,969. Obviously, investors who traded with these predictions did very well.

While it is always nice to reflect on correct market predictions, we must constantly focus our attention upon the future. After all, prior moves are in the book and the future is where we shall profit. Knowing this, we must reflect upon the rally that has been and the current state of the market.

As the Dow rallied 21% from the market lows to the March 26 high, calls of the bottom emerged from all corners. With prices pushing higher, fear, which had previously seeped in from every direction, quickly morphed into optimism. Having positioned for the transition and witnessed the change, we now ponder whether the mood has truly shifted and what the future may bring.

I hope this bear market and recession are approaching their end, but I fear they are not. The recent rally is the third time since the start of the bear market we have seen a fear-induced bear market low followed by a quick, sharp rally. As two prior 20% rallies failed, the current market is destined to travel in the same direction.

Measuring from the Dow's peak of 14,165 in October 2007 to each of the past three panic lows, we see ominous similarities. At the low of 8,175 on October 27, 2008, the Dow had fallen nearly 6,000 points or 42%. One week later the Dow was 18% higher and had erased nearly 24% of the prior year's loss. At the low of 7,552 on November 20, 2008, the Dow was down over 6,600 points (47%) from the peak it achieved 13 months earlier. One week later, the Dow was 17% higher and had erased 17% of the bear market's decline. Looking at the recent low of 6,547 recorded on March 9, 2009, the total bear market decline was 7,616 points (54%) over 17 months. One week later, the Dow was 18% higher and had eliminated nearly 14% of the bear market decline.

Throughout history, such sharp rallies signify bounces within an existing trend. New bull markets are not created by sharp rallies that eliminate 14% of a 17-month decline in one week. Instead, these movements are indicative of continuing bear markets that attempt to draw a frustrated public back in before prices collapse. This time will be no different. While the rally has lightened spirits and returned hope, the respite will be short lived. Prices will once again decline and we will eventually find ourselves becoming less exposed to equities. For now it is a question of when, not if. Knowing massive amounts of money are lost by investors lured back into the market by false rallies, we must remain cautious.

Looking at the current state of affairs, I see more risk than reward. After being severely oversold at the beginning of March, markets have now moved to an overbought condition. The typical bounce off government intervention has occurred, but will also fade. As we prepare for what should be a horrific employment report this Friday, we must also look toward earnings season. With the market extended and bad news looming, the market will retest recent lows. Investors are well served to treat the recent advance as a respite in an ongoing bear market.

This bear market will eventually end. However, it will not occur with 18% moves in one week. Instead, it will limp to a close when investors have abandoned hope and stocks are universally cheap, yet the economy finally rests on solid footing. At the moment, those days remain well into the future.