Technician: Violent Corrections Typical of Late-Stage Bull Markets; Focus on Large-Caps

For the past two years, stocks in the S&P 500 and Dow Jones Industrial Average have moved higher in almost a straight line. Then, as we entered the fourth quarter of this year, they suffered a steep decline and briefly broke through long-term moving averages—causing many traders to question whether this was the end of the bull market—before quickly reversing course and shooting back up to new all-time highs. What gives?

Lowry Research’s Senior Market Strategist, Richard Dickson, tells Financial Sense Newshour that this is an example of the type of behavior you start to see towards the latter stages of a bull market, which, he says, "is fairly long in the tooth from historical standards."

Though he still does not believe we've reached the ultimate peak yet, Richard notes that the market has seen some major deterioration, especially in small-cap stocks, and that investors should be rotating into more defensive large-cap stocks.

You can listen to his entire interview with Financial Sense Newshour by clicking here (starts at 19:00) or in iTunes here.


What do you make of October’s V-spike in the markets?

“Well, we’ve got a bull market now that is going to be almost six years old in March so this is fairly long in the tooth from historical standards. And typically as a bull market gets older you tend to see more violent corrections. So, the drop that we had September to mid-October strikes us as one of those violent but brief corrections that occur late in a bull market.”

What types of buying and selling pressure dynamics are you observing?

“[W]e are again seeing a rise in selling pressure and a drop in buying power just over the last couple of weeks as the market continued to move higher. At the same time our short-term measure of demand on our short-term index has dropped pretty sharply, so that suggests to us that what you’re seeing right now is a real case of buyers fatigue. So the market could well be vulnerable to any uptick that you get in selling. In many ways what we’re seeing is similar to the market conditions as we approached that top in September.”

Given the above, are you seeing anything that would indicate we are getting close to a major top or peak in the stock market?

“Not yet. It’s surprising, really, if you look at the advance-decline lines for instance…historically, you’d expect to see a series of lower peaks in the advance-decline line as you come closer to a market top. The fact that you were able to get back to that September high, actually a little bit above it, really breaks that pattern of lower highs…This latest rally though ended that. So, as far as we’re concerned, the clock hasn’t even started ticking yet towards the market top.”

Are you eyeing a timeframe for when that might happen?

“One thing I’ve learned over the years is never forecast out a year or so from now. It’s no better than a guess. We basically say, ‘Who knows where the market is going to be six months from now, a month from now. Let’s see what the market tells us as far as what its current conditions are.’ And the way things stand right now, we just say, ‘How do we want to invest in this market?’ And I think the more important thing to keep in mind is where do you want to be invested? And, in particular, do you want to be in small cap stocks right now? You have 40% of small-caps down. What are your probabilities of finding those two that are doing as well or better than the market? You’re much better off sticking with the mid-caps and the large-caps, and eventually you are going to see that deterioration extend into the mid-caps. Then you want to be concentrated in the big-cap stocks. So, as far as trying to pick when the ultimate top of the market occurs, it is almost too late because by that time you would have seen a deterioration as things are going now in small-caps, then in mid-caps, then it’s going to work its way into large-caps. So that last day of the bull market, you may have stocks where the majority of your portfolio may already be down maybe 15 or 20% simply because of the deterioration that takes place. So, you know, the ultimate top in the market is nowhere near as important as identifying that process of deterioration that is taking place, and continually upgrading your portfolio to get out of those stocks that are now starting to lag and are going down 15 or 20% and concentrating more and more in those stocks that are still fully participating in the rally. That way when you do finally hit the final up-day and things start going down, at least you have a cushion so that if you don’t sell right at the top, your stocks are still going to be among the strongest stocks going into the top. Then you should have some time to get out without suffering any serious kind of loss.”

A lot of what’s going on in the market also relates back to interest rates and the relative return of stocks vs. bonds. How much pressure do you think this will put on the market then if the Fed starts raising rates?

“That’s really going to depend on what’s happening with earnings. If interest rates are simply going up because the economy is getting stronger and stronger, the initial effect of higher rates is not going to be negative; it’s going to be positive, because it will reflect the strength of the economy. At some point in time, yes, you will reach a tipping point where the higher rates will be perceived as eventually causing a slowdown in the economy and that’s when you are going to see the market go down… Now if they just start raising interest rates simply because they are afraid of inflation or they want to keep the dollar strong or something and the economy is not particularly strong, and the economy is starting to slide a little bit, then that would clearly be a negative for the market. But judging from what the Federal Reserve has been doing, it seems hard to believe that if the economy is softening that they are going to start raising interest rates. So that does not strike me as a real likely scenario. It seems more probable they would raise interest rates only in the face of continuing strength of the U.S. economy and that is not negative for the stock market.”

End partial transcript

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