Today’s Bull Market Is Tomorrow’s Bear Trap

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Includes: DIA, QQQ, SPY
by: Keith Fitz-Gerald

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.

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