5 Signs the Bull Market Is Intact

by: Alan Brochstein, CFA

The market briefly moved into the red for 2011 last week, actually closing down on a YTD price basis (but not including dividends) before recovering late in the week. While I was a bit surprised by the extent of the retreat, it's not at all surprising given how extended the averages have been and how long we have been rallying without any hesitation. While we may have a bit more to go, I believe that this move will be characterized as a pullback and not a correction (a retreat of 10-20%) or a bear market (a decline of greater than 20%). What gives me confidence that the Bull is alive?

  • Corporate Spreads are Stable
  • Small-Cap is Performing Well
  • Emerging Markets Stable
  • 1220-1250 Support Zone
  • Breadth Still Positive

I believe that the number one threat to the bull market is higher interest rates, especially corporate bonds. It's potential competition as well as a potential inhibitor of earnings. Higher rates could lead to a double-whammy: Lower PEs and lower earnings. While I believe that there is substantial slack before it becomes problematic, increasing rates would still cause some concern. Junk bonds are stable, as are corporate bond spreads. As you can see in the chart, corporate bond rates remain low:

click to enlarge

While Small-Cap stocks struggled early in the year, they made up a lot of ground in February. In March, with the S&P 500 down 3.5%, the Russell 2000 has declined slightly less. I find the ability of Small-Caps to hang in since the market peaked in February to be encouraging.

Similarly, Emerging Markets have been lagging the market for a while, yet they have recovered a bit of ground despite lots of global turmoil lately. Given how much our Industrials seem to depend upon exports, the stability in emerging markets despite aggressive tightening policies is another indicator that the markets are alright.

1220 on the S&P 500 was the peak a year ago. To me, support looks like it's in the 1220-1250 zone, and we bounced quickly there last week. If one measures from the lows of the correction over the summer to the peak in February, the 38.2% retracement is 1217. Similarly, the last Fibonacci retracement of the 2007 peak to the 2009 low was 1229 (in the middle of the 1220-1250 support zone). If we pull back all the way to the bottom of the support zone, we will still be down less than 10%. The rapidly rising 150dma should be moving into the bottom of this support zone too. We got a correction when the market advanced from the 666 low to 1220 (+83%), while the move from 1011 to 1344 (34%) is likely to engender a pullback.

Finally, one of the sure signs of a weak market is deteriorating breadth. I have been concerned because Energy has been so strong relative to the rest of the market. Still, if we look at the entire S&P 500, we see that the stocks that are up on the year number 308, or 62% of the index. In fact, more than 1/2 the stocks are up more than 2% (261). I would add in that 91% of the stocks in the S&P 500 have a 50dma above the 200dma, suggesting stocks remain broadly in a bull trend despite the concentration of leadership in Energy.

So, it appears that we are enduring a pullback. The last bull market never saw a correction, but there were plenty of pullbacks. This bull market has already experienced a correction, which most likely cleared the way for a sustainable rally through 2012. Too many stocks were extended in February, and too many sectors were overheated. The market is back to being a two-way street again, a much healthier environment, after this apparent pullback.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.