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Stock Market Evidence: Bull Market or Bear Market Rally

We’re going to look at both sides of the equation from a relatively neutral posture, weighing the evidence as to whether we have a final low in place or whether this is potentially a bear market rally.

First of all, I’m looking at the nearest futures contract. This is the chart, basically a working copy of the chart. On a percentage retracement basis, we have exceeded the greatest percentage retracements during the Great Depression. We have done so over a very short period of time.  Only the June 1930 rally unfolded as quickly as ours. We’re pretty close to the November of 1931 rally, so obviously it’s within the realm of possibility that this could be a bear market rally high based upon time. I don’t have a problem with that. In the video, I show a table displaying the actual percentage rallies of the greatest legs up in history.

I believe the retracement of the previous leg down, is the most important part of our analysis in this situation, based upon the law of action and reaction. In this case, the Acti0n would be the decline, and the Reaction would be a percentage of the previous action down. We have exceeded the greatest retracements during the Great Depression. That is an interesting point that we have to be aware of, and the market may be showing that it’s divorcing itself from the DNA of the Great Depression. I had presented that working, or potential assumption in our previous couple of updates.

From March 6th to April 2nd, the S&P rallied 27 percent in 27 days. Needless to say, that’s a big-time advance, retracing 65 percent of the decline. This ranks at number two out of 52 bear market rallies in history. If this were a bear market rally, in terms of the velocity of the advance, it would rank as the second greatest in history.

In the video, I show the greatest velocity legs up in history.

For example, after the crash of 1929, we experienced a leg of 47 percent off the lows in four months and 28 days. The rate of gain would have been a .32 (percent per day). Our advance has been .99, almost three times the rate of gain during the first bear market rally in 1929. While we fell 20 percent short of the overall percentage advance, we did so in an extremely compressed time period.

The bear market rally in 1929, while it was the greatest percentage bear market rally in history, it only ranked as the 15th greatest, in terms of rate of gain. The velocity of the current rally, if it’s a bear market rally, is right up there with the greatest, the most elite of the advances.

Amongst the four closest fit bear market rallies to ours, the 25-day rally in 1931 ranked as the greatest. The second greatest was in 1931, one month and four days, 31 (percent per day). Ours has advanced a little bit more violently than that. This was a .87; ours is a .99. Then we had a couple of others here, .83, that actually occurred during the bear market in 2002. Number four was the rally which we experienced between November of 2008 and January of 2009. We actually advanced 27 percent into that January high, which is exactly our advance.

We do have to take note that there is historic precedent for a bear market rally to be very short-lived like this. Does this mean that this could be a bear market rally? It can. If I set a ledger up and say, “Well, these are the factors which argue for a bear market rally on the left side, and these are the factors which argue for a final low on the right side,” I’d have to say that there are factors on both sides of the equation, so we look to see more and more evidence way towards one potential outcome or the other. That’s where I am right now. I’m ready to maintain a flexible, neutral outlook, but I’d mention some of the things that would appear to evidence that a final low could be in place.

Historic Analysis of Violent Bear Market Rallies

In great bear markets like this, you can have a bear market rally, which experiences a violent advance in a short time period.

This is a completed leg up in a bear market. It is second only to the rally into the June 27th, 1931 high in terms of velocity. It’s extremely overbought. If this is a bear market rally, probabilities would favor that we have a high in place.

Two of the top four velocity advances occurred during the Great Depression, one during our bear market, and one during the 2002 bear. So we do have precedent during the Great Depression. Two of the advances had the same DNA as ours, so we have to make note of that.

Finally, if this is a bear market rally, there is compelling arguement in the four closest-fit precedents for the market to reverse lower from here. The stock market has advanced 27 days as of April 2nd. Now we’re out to April 6th as of today, so we’re 31 days into this potential bear market advance, this leg up in a bear market. Well with the four closest fits, the longest time period was one month and 16 days, three were one month and four, 25, and 29 days.

If you are looking for a place to enter a short position, if you are bearish the stock market, then this, presumably, would provide you with some evidence that this thing has the potential of turning around very quickly and moving down.

After the 1931 advance, we actually experienced the final leg down during the Great Depression into June of 1932. The stock market dropped 62 percent in one leg. If we were to replicate that leg, we’d go from 847 down to the lower 300 level. If we replicate the October of 1931 precedent, a very violent leg as well, on a percentage basis  that would carry us below 500.

In 2002, you can see that that leg down actually culminated. The reason is  that was a final bear market low in October of 2002. In other words, once there is a culmination, a final low, that means that now it’s a green light for expecting a bull market.

October of 1931, that was a leg down in an overall bear market, which was followed by a leg up in an overall bear market, and a continuation of the bear. In March of 2009, we don’t know how that’s going to resolve itself. We don’t know yet whether this is a final low in a bear market, or whether that is simply an intermediate low prior to a bear market rally.

Participating in the Stock Market

While the percentage declines and time periods of the declines experience great variation, the velocity of the declines did not.

If this is a bear market rally, and we are going to see another leg down, then we don’t have time, at least based on the closest fits, to experience additional upset. We could push to a new marginal high or something, but we’re basically running out of time. .

It’s kind of a make or break situation. Either we’re going to conform to the historic “bear market rallies,” in which case we should be very close to being complete, or if we divert from them and continue higher, we’re going to know that we’re wrong. In that eventuality, we would obviously be looking to cover any short option positions.

If I was looking at the other side of the equation, and looking at the potential for appreciation in buying puts, it’s not there because the premiums are so high. In addition, I’m viewing this from a neutral standpoint as far as the trend is concerned. I’m not convinced one way or the other as to whether this is a bear market rally or a first leg up on a bull market. We’re going to step on the other side of this equation and see what this looks like relative to legs up, the greatest velocity legs up in history in bull markets.

Potential for a 1st Leg Up in an Overall Bull Market in Stocks to be Underway

Note here that I’m just throwing in the NASDAQ again because, again, it has a different look than the S&P 500 (see chart in the video). We made a higher bottom, and we made a higher high above the January 6th high. This is one of the points that we had placed on the bullish side of the ledger, that the NASDAQ, the high tech stocks, are not playing the game with the S&P 500. We have a schizophrenic technical picture in the stock market. When I say schizophrenic, that means that there’s kind of a tug of war between what the tech sector is saying and what the large cap stocks of the S&P 500 are saying.

The market is kind of in limbo here. Presumably that would work in favor of call option writers and even put option writers. Based on this significant advance in the market, should we see a top established, selling call options at the termination point of a rally would a trade recommendation we would make for subscribers.

Greatest Velocity Advances in Stock Market History

The last table (see video) I show the great velocity advance legs up in history in the S&P 500 and the Dow back to 1886. We are in very elite company as far as this current leg up of 27 percent. This 27 percent advance in 27 days ranks as the third greatest in terms of velocity advances in history. Only two other legs in history have advanced as rapidly as this.

1987: this is something of an aberration. I almost have to throw this precedent out because we saw the market move up 20 percent in one day. In one sense, it doesn’t really qualify as a leg up, but it has found its way into the data. I am going to dismiss that as a closest fit for our market since we have advanced 27 percent in 27 days.

Final bear market low in 1932: After the culmination, bankrupting low had been placed in 1932, the market advanced 112 percent in three months and six days.

Now, our market has dropped approx 58 percent from high to low as far as this overall bear market. The S&P during the Great Depression dropped 87 percent, but many stocks went bankrupt. The financial damage was worse than what the index represented, and yet the index dropped 87 percent, a horrible situation. By the law of action and reaction, once you have culmination lows where a market gets pushed to that kind of an extreme, it is not a surprise that the market is going to have a snap-back rally, so to speak, and that is what occurred in 1932.

What do we learn from that with regard to our situation? We have to log that into our memory as well since we are in the middle of the second greatest bear market in history. Then the first leg up presumably could be of the highest order. At this juncture we are up 27 percent. Can we go further than that if there is a low in place? The answer to that question is yes, but I don’t think that is going to happen. Again, we are dealing with a ledger: bullish factors on one side; bearish factors on the other side.

You look at these, and then it just gets down to probability. We are not in the business of being right in the markets; we are in the business of putting in the right kind of bets or speculating at the right points in time, knowing that a certain percentage of those aren’t going to work out, but a greater percentage are going to work out. Hopefully you are making more money on the profits than the losses, and that is how the whole game is played.

1974: This is a very interesting precedent because this is the recession of 1974 which is the third greatest bear market in history behind 1932 and our bear market. While in 1974 the market declined 50 percent, you would have to say the 2002 market was comparable as well. The first leg up was a very sharp 21 percent in one month and four days. After the November 7th, 1974 low, there was a quick spike to the up side, and then the market experienced a retracement into what would have been a higher bottom. That was the point in 1974 to really load up on the long side of the market for what would be an approximate two-year bull market into the 1976 high.

We do have a precedent in 1974 that suggests that the first leg up off a bear market would be very short lived, very sharp, followed by backing and filling. In our situation, the equivalent is if we have a final bear market low in place, we’ve had a sharp first leg up, we are going to see some backing and filling, and then we will see the market experience a second leg up in an overall bull market.

However, as I have said right along, this is the environment in which I believe it is prudent to sell options because the traders out there are bidding them up. The sellers are not coming to the table because of all the volatility that has taken place over the last nine months, so you have these exorbitant premiums.

I did want to say that for those of you that do option writing that look at situations like this, I believe the S&P is in a very interesting position to write call options or write options, period. When I do that, I generally risk 100 percent of what I expect to make on an option.