THE BLOG'S THREE MAIN OBJECTIVES:
~*Revealing and Getting Rid of Scams | Creating Honest Sustainable Wealth | Offering Happiness, Safety and Legitimacy*~

Wednesday, 25 March 2009

Bear market rallies can be violent and exciting

by Mark Hulbert

Is it possible to have too much of a good thing?

Mae West didn't think so, though I have it on reliable authority that she wasn't talking about the stock market.

And when it comes to rallies off of market lows, it is indeed possible for stocks to overdo it. That at least is the argument being made by at some of the investment newsletter editors I monitor.

According to them, bear market rallies are almost by their very nature powerful and impressive. If we were to endow the bear market with intent, we would say that the very purpose of a rally is to draw as many gullible investors back into the market before the next leg down commences.

Richard Russell, editor of Dow Theory Letters, puts it this way: "In bear markets, corrections against the primary direction tend to arrive without warning and are very rapid, often recovering in a week the bear market damage of a few months. Part of the attraction of a bear market rally [correction] is the speed of the advance. This makes the rally doubly attractive and allows those still in the market the fantasy of recouping their losses in short order."

It's probably not an accident that Russell would make a statement like this, given that he is a close follower of the Dow Theory. Of any of the major stock market theories, it is the one that perhaps pays the most attention to the distinction between primary and secondary trends. It traces its roots back to William Peter Hamilton, who introduced it in a series of editorials in The Wall Street Journal over the first three decades of the past century.

Robert Rhea in the 1930s took up the task of codifying Hamilton's editorials into a coherent theory. Russell recently quoted Rhea as saying the following about secondary reactions:

"One definite characteristic of secondary reactions is that the movement counter to the primary trend is always much faster than that which occurred during the preceding primary movement. Hamilton noticed that 'in a primary bear market, the rallies are apt to be violent and erratic, and always occupy less time than the decline which they partially recover'."

Rhea also wrote, according to Russell, that "secondary reactions may occur with amazing rapidity."

Russell's and Rhea's comments caught my attention because, whatever else you say about the rally that began two weeks ago, it has indeed been "violent" and has occurred with "amazing rapidity."

To gauge just how violent and rapid it has been, I compared the rally since March 9 to a composite of the stock market's behavior over the first two weeks of all bull markets since 1900.

To come up with a list of those bull markets, I followed the lead of Ned Davis Research, the institutional research firm. For them, a bull market requires one of three conditions to hold: (1) at least a 30% rise in the Dow Jones Industrial Average.

Since the beginning of 1900, according to the research firm, there have been by this set of criteria no fewer than 34 bull markets.

It turns out that the recent rally has been markedly more powerful than the average beginning of prior bull markets. Over the last two weeks, for example, the Dow has gained 18.8%. The Dow's average gain over the first two weeks of past bull markets, in contrast, has been 8.4%, or less than half as much.

In fact, of the 34 bull markets identified by Ned Davis Research, only one of them produced a greater gain in its first two weeks than in the recent rally. That was the one that began on November 13, 1929, and is hardly one that the bulls would want to brag about. That bull market lasted just five months and led to an increase of just 48% in the Dow -- making it one of the most modest of bull markets in the sample, despite have one of the most impressive returns in its first two weeks.

These historical comparisons don't automatically mean that the market's strength over the last two weeks is just a bear market rally, of course. But those comparisons do highlight the possibility that the recent rally, impressive as it otherwise is, will in the end prove to be just a bear market rally.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
Copyrighted, MarketWatch. All rights reserved. Republication or redistribution of MarketWatch content is expressly prohibited without the prior written consent of MarketWatch. MarketWatch shall not be liable for any errors or delays in the content, or for any actions taken in reliance thereon.

1 comment:

Eric said...

It seems a bit early to sing "Happy Days are here again", but at least Spring is upon us here in Belgium, and the weather over Easter has been superb in Northern Europe.
But there is a lot of volatility in the Stock Market, so the in-and-out specialists must be having a field day.

Goldman Sachs Information, Comments, Opinions and Facts