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Last month I proposed the possibility that the S&P 500 was forming a rounding top. Prices have since traded above the apex of the arc disproving that theory.
Since the market continues to levitate, to everyone’s amazement, let’s check back with the theory that this could be a secular bull market. The birth of the 1982 super-bull had an interesting characteristic. Usually the market acts like a rubber band, stretching to one extreme before snapping back. One way to monitor it is to compare the closing price to a long term trend, for example, the 200 day moving average.
Recently, this has been very accurate in pinpointing tops. The S&P 500 usually has difficulty maintaining a run when daily closes are 20% above its long term trend and in the past few months this helped us to identify the tops in mid-September, mid-October and then again in mid-November: Stocks Have Little Room To The Upside.
But in 1982 it consistently pushed that boundary. You can see a chart of what I mean here: Do Bull Market Rules Apply? Today’s S&P 500 isn’t following that script. The rise has been relentless but gradual. Not the turbo-boosted rocket ride we saw back in 1982. A secular bull market is doubtful for many other reasons as well. Casting about for a proper analogy for the present market conditions, I considered the 1974 bear market low.
It isn’t a perfect analogy but in one respect it stood out for me. Just like the recent tape, after the 1974 bear market, the S&P 500 staged a massive rally creating a spike low on the charts. Prices retraced an astonishing 78.7% before topping out in September 1976:
For the initial counter trend rally, the 20% level was helpful in spotting a top in July 1975 (red arrow). But it was totally oblivious to the more significant tops in September 1976 and January 1977 (red question marks). The reason was that the retracement had caused the 200 day moving average to rise very steeply. Just like we are seeing today. Since the long term trend was rising faster than daily prices, their ratio was actually falling.
By January 1977 the S&P 500 had been going sideways for a whole year. That stopped the 200 day moving average from rising further as it plateaued for a few months in early 1977 and then started to fall gradually.
My point is that because today’s long term trend line is rising at a similar slope, this otherwise useful indicator could fail. But nevertheless, according to other indicators, like sentiment surveys and option traders, we are getting the message that a top is imminent.
From here, it would take a 4% jump in the S&P 500 to move it 20% above its present 200 day moving average. But even without such a signal, I continue to be cautious in the short term. A significant retracement is characteristic of the aftermath of secular bear markets. What follows after the initial counter trend rally is a secondary correction that usually lasts about a year and takes prices down 25%. You can see that play out to almost clockwork precision in the above chart.
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