About an hour north of San Diego County is Greater Los Angeles, which is commonly referred to as the Southland. This five county area is massive; almost 4,900 square miles with a combined population of over 17,700,000 people according to a U.S. Census Bureau estimate in 2006. The borders extend from Ventura County to the north, Orange County to the south, the Pacific Ocean to the west, and the Inland Empire of San Bernardino and Riverside Counties to the east.
Reading the stock market is analogous to trying to understand how the Southland functions. You could spend days in each of the five counties in order to gain an in-depth understanding of what is happening in those counties, or you could view the same area from 10,000 feet in a helicopter for a different perspective.
Fundamental analysis is how most analysts gain the in-depth perspective to each of the stocks that comprise their universe. Technical studies provide the high-altitude perspective, which shows, from a wider viewpoint, how stocks and the market are operating.
It is from this high-altitude perspective that we can see the repetitive five-movement patterns or legs that make up all major trends. In terms of the Dow and the S&P, both indexes bottomed in March ’09 and rallied into early June ’09 for the first leg. The second leg was a corrective or profit-taking move down that finished up in mid-July ’09. The third leg, which is always the most powerful in terms of time and price, was a rally to April 26 of this year. The fourth leg was another corrective or profit-taking decline that ended on July 6th. The fifth and final leg of the trend that started in March ’09 is now underway and based on time and price should last until early October.
For comparison purposes and to illustrate this five-movement pattern, I have provided a chart of the 1966 to 1974 bear market and a chart of the bear market that began in 2000. If the current pattern continues to unfold as I believe it will, this current rally should be the fourth or last corrective leg of the larger bear market trend and that the fifth or last leg down lies ahead of us.
That I believe that the bear market is not over should be nothing new to those who are familiar with my work. However, the unfolding market pattern is now more easily distinguishable, which gives us a better roadmap to follow. So the good news is there is still upside, probably into the fall, and maybe even longer if the current tax policy on dividends and capital gains is extended.
Make no mistake about it though, the fundamentals, which are horrible, will eventually out and all sins and excesses will be purged. There will be places to invest during the purification, there always is. If I had to speculate, I would think one area would be the pharmaceuticals, which have been in a dreadful bear market since 2000. This would be perfect in its own symmetry as absolutely no one has any expectations for that sector.
In the meantime though, when Chairman Bernanke uttered the words “unusually uncertain” in his testimony to Congress, what he was telling the markets was that the Fed policy would not change, most likely well into 2011. If there was ever a green light to go into risk assets I haven’t seen a better one. A further confirmation is the recent classic Dow Theory buy signal when both the Industrials and Transports closed convincingly above their June highs on July 26th.
Lastly, the utilities have been ever prescient in signaling a change in trend, which should provide an early warning signal before the broad market tops. So relax and enjoy the summer.