Today’s Bull Market Is Tomorrow’s Bear Trap

Depending on your perspective, U.S. equities are either at the edge of another cliff or at the dawning of a new bull market.

We could make the case for either. But in as much as that would be an interesting exercise, the more relevant question is what the data suggests.

Let’s take a look.

Since their 52-week highs last October, the Dow Jones Industrial Average Index has lost 18.5%, the S&P 500 Index is off 18.2% and the Nasdaq Composite Index has fallen 15.1%. At the same time, the broader U.S. economic picture has darkened considerably with gross domestic product [GDP] a slim 1.9% and consumer confidence in the toilet bowl rather than the punch bowl.

Adding insult to injury, sentiment is worsening. Even perma-bulls are tempering their expectations and volume remains decidedly concentrated on the downside.

Yet, at the same time, the Dow puts in two barnburners like those last Tuesday and Friday when the index rose 331.62 and 302.89 points respectively.

Which begs the question… what do we make of the rallies?

Two words – “bear trap.”

David Rosenburg, an investment analyst with Merrill Lunch & Co. Inc., points out something we know from our own proprietary research to be true. There’s never been a 300-point rally in a bull market. Let alone two of them in one week.

Sure we’ve seen larger proportional percentage gainers in the past but the point remains. Massive up days suggest significant short covering and further downside ahead.

If history holds true, then there are three key takeaways:

• Until the rebound reflects stronger earnings, sales growth and a generally improving economic scenario, rapid upside moves like those last week are nothing more than king-sized bear traps ready to snare the unsuspecting.

• Companies are girding for rougher times ahead by selling into strength. This would not be the case if things were truly getting better. Nor would London Interbank Offered Rate [LIBOR] /Treasury spreads be widening the way they have been recently.

• What we are experiencing now is nothing more than a continuation of the broader bear market patterns that began in 2000 and which may continue through 2012 or 2015.

What to do now:

While this sounds terrible – and admittedly it’s sure not going to be fun – this too shall pass and probably when most people least expect it to.

Which means that rather than concentrating on hitting home runs, investors would be better served by playing a “defensive” strategy for the foreseeable future.

The best choices remain overseas equities and, in particular, companies doing business in Asia for the simple reason that we have not witnessed the same economic fall off in many parts of Asia that we have in the United States.

Not only are the consumer classes of these Asian markets still growing in strength, but also they’re becoming a force all their own. Which means that these markets will likely lead the way out of this mess even if they take a few hits in the meantime.

Original post

Comments

[investor88:]

Agree US in bear market but the conclusion that Asian markets will lead the upturn is subject to debate. Thus far in the past year Asian equity markets have actually fallen more in percentage terms than developed country markets like the USA. Some like Frank Rong in recent articles in SeekingAlpha says the Chinese market is a bubble about to burst. We have to respect both sides of the argument and watch developments closely.

2008 Aug 13 04:53 AM

[rank17:]

I'm sorry, but you shoot yourself in the foot with your first key takeaway -

"Until the rebound reflects stronger earnings, sales growth and a generally improving economic scenario, rapid upside moves like those last week are nothing more than king-sized bear traps ready to snare the unsuspecting."

If you'd been around for the past half dozen major market turns (and history actually suggests most of those prior to this) then you'd know that this is absolute rubbish.

Stronger earnings, rising sales and a generally improving economic scenario are almost always lacking over the first weeks and months of a major bottom.

2008 Aug 13 05:03 AM

[gabe borens...:]

The rules are made to broken.We we will see consecutive rallies that will exceed 300 points.The investment landscape has changed .The problems that have temporarily derailed U.S economy ,I have discussed since June of 2005 in various media interviews and have reiterated them on Bloomberg T.V(Brian Sullivan interview )as late as September 18,2007.The U.S economic/market issues have been identified and are being addressed by corporate America,the FED ,the Administration and the Congress.The problems that we had to face ,exist in Europe and certainly greater risks exist in the Emerging Market economies which are leveraged to the hilt .More importantly that region's economic survival depends on the high commodity prices.
Europe is still victim of ECB's high rate policy.
It is likely that Europe ,Asia (still dependant on the U.S demand)and Emergimg Market economies are heading for a major economic implosion which will create (already) does , a record demand for the dollar denominated assets .
This demand will fuel the unprecedented stock market rally in the period ahead.It will stabilize and driver the real estate prices sharply higher .
The monetary and the fiscal measures place , are already consolidating various markets(allow for the lag).
The time for caution was in 2006 when 20% of all the homes sold were financed by the sub prime funding.I have issued the warning then and earlier.
The time for caution was in the mid of 2007 when economic optimism and stock evaluations made no sense.
Now that the U.S had faced and is addressing all of the problems ,we are at the begining of the unprecedented stock market rally .The Dow at 20,000 and the NASDAQ at 7000 are reality .
For all of the expert recession prediction ,we are not in one (2 consecutive quarterly GDP declines).
My track record?one more time .....I have issued warning about the current debacle as early as June of 2005(Mark Gilbert -Bloomberg ,London) during an interview-there were few takers.
Now,the more bearish analysis I hear,the more bullish I become.
Market volatility is unavoidable but the outcome is clear -major stock market rally.

2008 Aug 13 07:18 AM

[User 59050:]

thanks, keith . .interesting comments. appreciate your time.

2008 Aug 13 08:47 AM

[neeb??:]

300 point rises nothing more than buying into dips.
I expect the same thing that happens here is going to effect asia as well. That too is a 'bear trap'.

2008 Aug 13 09:09 AM

[cyclingscholar:]

Get your facts straight, HOSER! ;) The on-balance-volume in SPY, DIA and especially QQQQ is far better than any rally in this market so far. Not that this disqualifies your premise, but I am deeply suspicious of anyone who makes such a bogus claim so easily disproven by a few clicks and a few facts.

2008 Aug 13 09:21 AM

[fxtrader07:]

those looking to hide in Asia will get a nasty surprise.

@gabe borenstein: 'Now that the U.S had faced and is addressing all of the problems ,we are at the begining of the unprecedented stock market rally .' Helloo?? Infrastructure in the usa is in a misearable shape, so is energy and energy policy, healthcare. government budget will face a trillion $ deficit during the next presidency - no matter who wins. problems are being adressed?? They have not even started to get adressed. Waht is done now are emergency rescues. the long term lingering problems have not even be spelled out by any of the presidential candidates. go figure

2008 Aug 13 09:31 AM

[Emerald:]

No disclosure by author as to positions. Sounds like he needs to sell more into these bear trap rallies. Comments by fxtrader07 are right on the money.

2008 Aug 13 11:13 AM

[Emerald:]

Sorry. Meant to write no position disclosure by comments by gabe borenstein

2008 Aug 13 11:14 AM

[secmaven:]

And the way the current problems have been "addressed" is laying the foundation for even greater financial problems in the not so distant future.

2008 Aug 13 12:49 PM

[gabe borens...:]

One more time.Europe ,Asia and the rest of the Emerging Markets are heading for a major decompression.U.S barely deflected one by incredible cooperation amongst the FED ,The Congress , the Treasury and the Administration.U.Secon... is on the verge of a major non inflationary rebound .Decompression in the other economic zones will fuel the U.S rebound and the dollar denominated assets.Volatility will continue but the economic/market trend is uppppppp.

2008 Aug 13 01:27 PM

[User 167224:]

you mean 'bull trap' not 'bear trap'..........if you don't believe in this rally then you mean to say that you are trapping 'bulls' i'm sure it was a typo.

2008 Aug 13 07:27 PM

[CLH:]

To bet on a continuing bear market is to leave the market and hide under the bed. (Actually we are not in a bear because we are not down over 20%). Gabe may be a little too optimistic, but Im on his side. Market corrections are needed and bring on great opportunities for making money.

Keith---- +300 points up are death for the bears and mean they are on the wrong side of the market.

2008 Aug 14 08:10 AM

[Paul D. Cas...:]

I agree with those here who dispute the basic premises of this article. In fact, as per research done by Bespoke (see link below) 300 pt rallies in the DJIA have in the past occurred at the start of big uptrends.

bespokeinvest.typepad....

Since 1956 the DJIA has completed 16 downtrends (the current downtrend is the 17th). Those 16 downtrends (series of lower pullback low's and lower rally high's) have averaged 370 calendar days each and losses of each. Measuring from the peak on 10.09.07 to the most recent low on 07.15.08, the current downtrend has lasted 280 calendar days and evaporated 23% of the DJIA's value.

So far the current downtrend has been fairly typical and, if the historical averages are any guide, is pretty close to being over.

See my blog for similar analyses I conducted on the Russell 2000, the Nasdaq Composite and the S&P500.

www.vestopia.com/IDs/P...

2008 Aug 14 01:05 PM

[Paul D. Cas...:]

Oops! Meant to post that the average downtrend in the DJIA shows a 22% loss peak-to-trough.

2008 Aug 14 01:06 PM