Commentary for August 19, 2009

| August 19, 2009

Here is where things get interesting. Ever since the stock market decline of 2008 accelerated into a full blown crash late last year, the direction of stocks has been relatively predictable from a long-term perspective. Historically, all crashes of that magnitude are immediately followed by an equally violent rally that retraces a substantial portion of the decline. As you can see in the chart below, that is precisely what happened:

So what happens next? That’s a good question. Certainly, volatility will persist for some time, at least the next 6 to 12 months. Don’t let the quiet summer trading fool you. We are currently in the most volatile portion of this secular bear market, as evidenced by the extreme nature of the moves on the chart above, and it will take some time for any semblance of stability to return to the markets. Additionally, we can also be fairly certain that the secular bear market has many years left. Secular bears do not end with violent rallies, but rather with long periods of dull, slow trading as a disinterested and disenchanted public turns its back on stocks. That final phase of a bear primary trend, the aptly named despair phase, usually lasts for several years, and hasn’t even begun yet. We are currently in the recognition phase, during which investors come to terms with the fact that stocks are in a bear market, but continue to believe that the start of the next bull is right around the corner. Only when the majority of investors stop believing that the bear market is about to end does it have a chance to actually do so. If you need further convincing that the secular bear still has a long way to go, take a look at the current secular score graph:

The current reading of nearly -90 is very bearish and characterizes an environment that is extremely difficult for stocks in general.

Looking ahead, there are many possibilities. Stocks could sell-off this fall and then rally into next year. Or the March rally could extend up to about 1,100 on the S&P 500 index. Or the market could resume a slow grind lower into next summer. Like we said, after a violent bear market rally there are several viable scenarios moving forward. However, as long as you pay careful attention to what prices are saying in the present, you’ll know all you need to about the future. As Dow Theorists, we truly believe that tenet; it has served us well in the past and we foresee it continuing to do so. Let’s see where we go next!

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Category: Commentary, Market Update

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