I confess the bears are making me nervous. Red Herring twice noted the forecast of an unnamed technical analyst ("Mr. C") who sees a third leg of this bear market coming with the NASDAQ at 1900. I also read the comments of Mr. Steve Leuthold, president of The Leuthold Group in Minneapolis. He speaks of this same third downward bear market leg. He forecasts that "One year from now, the Dow will reach 8000 on its way back from a projected low of about 7000." Are we investing into a trap? What is this historical "third leg" of a bear market? I was looking at a 10 year chart of the Nasdaq and I don't see any such pattern in past corrections. (January 20, 2001)
There is a lot of noise out there. There is no shortage of prognosticators and it can be very, very confusing and distracting. Your email raises one of the biggest problems with technical analysis: guessing about where an index or a stock will be at a certain time. That gets off into the witch doctor aspect of technical analysis, and there is very little an investor can do to disprove such claims. Thus, many are scared off from investing, waiting for that inevitable downturn. Heck, we know some people here in the U.S and overseas who have been predicting an economic crash and corresponding stock market crash in the U.S. for the past ten years. Maybe they will be right; but can you imagine staying out of the U.S. stock market for the past 10 years? Many of those people are convinced that what is going on now is what they predicted. Nonsense. This downturn was caused by the Fed, not the natural cycle of the economy.
So, when the market is showing us that institutions are buying stocks as indicated by the higher volume on the rises and lower volume on the down sessions, do we just sit back and refuse to invest because there might be a downturn? There will always be downturns. It is up to us to protect ourselves with stop losses, mental or mechanical, and to avoid trying to step in front of a falling market with long term positions. As in the summer and fall, we had to look to the short term upside because the market was trending down; when it gave us an indication of a short term pop, we moved in, got a gain, and got out. Right now we are seeing good buying by institutions, and we are taking advantage of that. If it stops, we have to be ready to get out of the way. The rule: the market tells you what it is doing now, and there is no need to guess about what it might do in a month, at least when things look good for now.
Given that we need to keep an eye on the market here and now, what about the inevitable third leg that is being discussed? Looking at history, it is arguable whether every bear market has that 'third' leg down. Looking at the Dow, in 1981-1982, there were two. In 1974, you can argue if it was two or three. In 1984 it looks like two with a re-test of the low as the 'third' leg. In 1987: 2. 1998: 2. You could argue there were three, but the third was a test of the second low; it did not set a new low before rebounding. In 1987 it crashed, then tested that low twice before taking off again. A third leg down should be a final, new low, not a bear rally and test of a previous low. What some call a third leg occurs after a choppy period where the index hits lows rapidly, then runs up and rolls over for one more test. That looks more like two to us, not three; it is in the eyes of the beholder. The point is, the pattern is not consistent. You can cherry pick your bear markets and support your theory, but looking at several bear markets, there are different looks. By some of the past bear markets that supposedly had three legs, the current bear market on the Nasdaq would qualify: a plunge to the April low, a lower low in May, a rally up and then a plunge to the December low.
The overall point: we have to keep our eyes on what the market is telling us here and now. It was telling us it was time to buy starting at the Fed rate cut. So far it still looks good, but we are still in a bear market on the Nasdaq, and that means this could be a bear market rally. There is not a wealth of stocks in great patterns ready to head to breakout to new highs and lead things higher and higher; many still have to recover to their old highs first and bases are sloppy in some sectors (financials are not bad and semiconductors are forming the right side of their bases, and they are much better as their selling started earlier). Things could go wrong and we could get another test of the December low if this turns out to be a bear market rally.
The volume action we are seeing in the Nasdaq right now does not indicate a bear market rally as they usually occur on lighter volume. Still, that could dry up and send us down again. That is why we watch volume versus price action like hawks to see the telltale signs of institutions starting to dump stocks as opposed to buy them. If we see stocks start to fall back below trendlines or other support they just broke on rising volume, that is a sign the big money is leaving. On the indexes, if we see them breaking back below support on rising volume, that shows us the overall market is involved in dumping again and could lead to that fall back to test the December lows. At this point it is not doing that, and we can make good money by following the signs of the market and taking what it gives us. We have been making great money in this run; we look to make more as long as the move continues to show us the right kind of price/volume action. If we see that, we know big money is buying and that drives market higher.
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