Trader’s Narrative

While this bear market has unique hallmarks, there is something rather familiar about it. We’ve already covered many of the uncanny similarities between the last cyclical bull market and today’s market action.

For example, they both bottomed in March and the two charts look like they were separated at birth. The there’s the ensuing flag formation which played out in the same familiar way this year, as it had 6 years ago. And finally, there is the extreme breadth thrusts which are showing an intense, broad based rally pushing the stock market higher.

Maybe I’m seeing a pattern where there isn’t one but these similarities are too numerous and too picture perfect to simply dismiss. If you disagree, by all means let me know where I’m going off the right path.

But that’s not all. Let’s add yet another to the pile. Here is a chart of the 50 day moving average of the daily Nasdaq advance decline statistics:

If you look carefully, you can see that the bear market ended, at least according to this breadth metric, in July 2002. We then had a beautiful ABC pattern. This is Elliott Wave parlance for a three part wave pattern where the first part (A) takes us against the prevailing trend, then we have a corrective wave (B) and then a final move to complete the countertrend move. There is much more to Elliott Wave of course than this simple pattern.

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Getting back to the Nasdaq breadth, we see a very similar pattern end the bear market in late 2008 as it did in 2002. First, there was a very strong up move (A) and then a shallow retracement (B) and then a continuation move (C) in the original direction. Not only is the ABC pattern almost identical, it takes place almost during the same time of the year!

At the close last week, all major indices: Dow Jones Industrial, Standard & Poor’s 500, the Nasdaq and Russell 2000 - all closed at a new high for the year. And today, they again made new highs for the year (but closed lower).

The longevity of this rally is confounding both the bears and the bulls. That is if you can find a bull in this market.

One well respected market technician who has crossed over to the bull camp is Richard Dickson of Lowry Research who wrote today referring to last week’s market action:

There has been no evidence of deteriorating strength in each of the rally days this week, suggesting a continued healthy condition for the rally from the March low…

For more details on Lowry Research and their latest commentary, check out: Lowry Research’s intermediate trend buy signal.

Now that some time has passed I thought it would be opportune to reminisce about a chart that I brought to your attention as a musing of mine almost three months ago. It was a potential scenario that would have echoed the flag formation that we saw in the 2003 bear market low:

And here is what actually happened:

This is what I wrote when I featured the original chart:

Obviously what I’m showing is hypothetical - no one knows what is in store for us at the hard right edge of the chart. But I can’t help but project this potential formation onto the chart because of all the other similarities which we’ve seen so far between the two market periods. Although I didn’t foresee this rally coming and actually expect lower prices in the short term, I’m trying to keep an open mind because this rally has angered and confounded everyone. Just take a look at the recent comments here from readers!

Early July brought lower prices (eventually) and another, longer and more beautiful flag formation hugging the long term moving average. For me it wasn’t enough as I was expecting more of a correction. But what struck me most back then, as you can see from the quote above, was the lopsidedness of sentiment from most traders. I could scarcely find anyone who would publicly risk ridicule and criticism to be a bull. To some degree that is still the case today.

Apropos of nothing, if you haven’t listened to Leonard Cohen’s Hallelujah you don’t know what you’re missing.

In mid May, I pointed out the similarities between the technical formation we were seeing now and what we saw at the end of the bear market of 2002-2003: Comparing Wedge Formations: Then and Now. The S&P 500 has fallen out of the wedge formation - by trading below the lower trend line (see previous link for charts).

Something else noteworthy: the S&P 500 closed above its own 200 day (simple) moving average. For those keeping count, the index has spent 358 trading days below that threshold. And this is the second longest streak in its history! The one that was longer? You guessed right if you said sometime in the 1930’s (August 5th 1932 with 414 days).

The Nasdaq closed above its long term moving average in early May and then spent the whole month bobbing and weaving above and below to finally close 8.5% above it today. Even the NYSE Index managed to climb above this line in the sand. The Dow is the only major index still not above its long term moving average.

The next formation that we may end up seeing is what occurred in 2003: a flag consolidation pattern. According to Technical Analysis of Stock Trends by Edwards & Magee:

An Army that has pushed forward too rapidly, penetrated far into enemy territory, suffered casualties and outrun its supplies, must halt eventually, perhaps retreat a bit to a more easily defended position and dig in, bring up replacements and establish a strong base from which later to launch a new attack.

A Flag looks like a flag on the chart. That is, it does if it appears in an uptrend’ the picture is naturally turned upside down in a downtrend. It might be described as a small, compact parallelogram of price fluctuations, or tilted Rectangle, which slopes back moderately against the prevailing trend.

These pretty little patterns of Consolidation are justly regarded as among the most dependable of chart formations, both as to directional and measuring indications. They do fail occasionally, but almost never without giving warning before the pattern itself is completed.

You can see the flag technical pattern in this chart from 2003. The script sounds familiar. After making a sharp low in early March and bottoming, there was a sharp rally that propelled prices almost non-stop until June. From then until the end of August, prices traded in a tight range. After this pause, prices continued to rise.

(As you’re comparing the two charts, note that the vertical scales are slightly different.)

So far, we’ve seen a relatively small flag consolidation pattern which took the whole of May 2009 to develop. Here’s what we may see soon:

The benefit of such a scenario would be that as prices grind higher - two steps forward, one step back - the long term moving average would flatten much faster. Then it would rise to support prices from under. As you’ll recall, when we looked at the two wedge formations separated by 6 years, the position of the 200 day moving average was one of the glaring differences between then and now (Comparing Wedge Formations: Then and Now).

Obviously what I’m showing is hypothetical - no one knows what is in store for us at the hard right edge of the chart. But I can’t help but project this potential formation onto the chart because of all the other similarities which we’ve seen so far between the two market periods. Although I didn’t foresee this rally coming and actually expect lower prices in the short term, I’m trying to keep an open mind because this rally has angered and confounded everyone. Just take a look at the recent comments here from readers!

I’ve yet to read a comment from someone who is outlandishly bullish and riding prices higher. Instead all I see are various degrees of vitriol heaped on the market and anyone or anything that attempts to justify higher prices. That’s just an anecdotal layer of sentiment we can let fall atop all the other more formal ones. Just something to tuck under your hat.