The Spyder Trust (SPY) has had an impressive rally from the March 23 low of $218.28, and as of Tuesday’s high of $263.33, it was up 20.6%. As it turned out, the SPY closed down 2.1% for the week at $248.19. As the rally was progressing, many in the financial media have proclaimed that the stock market had bottomed. We all hope they are right.
Last weekend I gave an explanation of the anatomy of bear market rallies. My studies of past bear markets have shown that these rallies can take many different forms, but do share some common characteristics. I believe that by reviewing a number of examples, you will be better prepared for what lies ahead.
I don't think anyone has forgotten the 2007-2008 bear market, often termed “The Great Recession”. However, those who are new to the markets can still learn quite a lot from what happened between 2007 and 2009. The S&P 500 made a high of 1576 on Friday October 11, 2007 (point 1) and then declined to a low of 1406 on November 26. Twelve days later it had rallied to a high of 1523 (point 2), which was a gain of 8.3%.
The S&P 500 made a secondary peak in December that was below the new downtrend, (line a). Just five days later, the uptrend (line b) was broken, as the market’s decline resumed. By January 23, 2008, the S&P had declined 18.7% from the October high. This set the stage for a nine-day rally that lifted the market 9.9% from the low.
The S&P spent the month of February in a narrow range between 1395 and 1361. This sort of continuation pattern is typical action in a bear market. The heavy selling on February 29 indicated the trading range was over, and by March 17 it had made a new low of 1256. This meant the S&P 500 was now down 19.6% from the October high.
The sentiment readings from the American Association on Individual Investors during this period was quite revealing. The Bullish% peaked the week of October 11, 2007 at 54.6%, which coincided with the market high. By January 19 it had reached a low of 19.6%, which coincided with the January 23, 2008 lowand the ensuing 9.9% rally.
By February 28, the Bullish% had rallied back to 34.3%, but then two weeks later dropped to 20.4%. I was at an investment conference in early February 2008, where my role was interviewing many investment experts on camera. At that point, many of them were very bearish on the stock market, and most believed that a bear market was underway.
The rally from the March lows lasted until May 19, when the S&P 500 made a high of 1440. This was just below the 61.8% Fibonacci retracement resistance at 1454, which was calculated from the October 11 high.
On May 1, 2008 the Bullish% had hit 53.2% and the next week was 52.8%. By the mid-May highs, several of the former bearish experts had changed their view and some thought that it was no longer a bear market. The violation of the uptrend (line c) on May 21 indicated that that particular bear market rally was likely over.
By July 15, the S&P had reached 1200, which was down 16.6% from the May high, and down 23.2% from the October 2007 high. The Bullish% was down to 25%. The bear market rally lasted seven weeks, as the S&P rallied 9.4% from the July low. For most of August, the S&P traded in a fairly narrow band, until September 4, when the sellers again took over and the S&P dropped 3.3%.
This was the start of a serious wave of selling that by October 10had dropped the S&P to 839. That was a drop of 36.05% from the August high and a decline of 46.3% from the October 2007 high. The 200-point rebound from the low only lasted two days (see arrow) and soon there was another wave of selling.
At the November 21 low, the S&P was down 52.6% since the beginning of the bear market. From October 2007 to the March 9, 2009 low of 666, the S&P had a number of swings both up and down. This is not unusual when a market is bottoming.
Most of us have not yet forgotten the 2000 bear market in the NASDAQ Composite, which managed to end more than a few trading careers. The weekly chart shows the March 2000 high at 5132 (point a).
Below the chart is the 14-period relative strength index (RSI), developed by Welles Wilder. In an interesting side note, Forbes Magazine in October 1980 called Mr. Wilder as "the premier technical trader publishing his work today." Alongside the RSI, I have run a 21-period weighted moving average (WMA) of the RSI which is in red.
The RSI peaked in January and then formed a lower high in March, as indicated by the downtrend (line c). One day after the highs, the RSI dropped below its WMA, and the Nasdaq declined 13.2% over the next four days. The Nasdaq rebounded quickly but formed a lower high (point b). The RSI rebounded back to its WMA but did not hold above it, (see arrow), action which is consistent with a rally failure.
The next round of selling was heavier. By April 4, the Nasdaq had reached a low of 3649, violating the January lows. This triggered some quick buying: four days after the lows, it hit 4475 (a rally of 22%), before reversing to close lower for the day. By April 17, the Nasdaq had reached a low of 3227, which was a decline of 37.1% from the high. The new correction low was accompanied by a new low in the RSI.
The nine-day 23.4% rally from the lows was followed by a reversal to the downside the next day. This often occurs during bear market rallies. The next wave of selling lasted until May 24. At the low of 3042, the Nasdaq had dropped 40.7% from the March high. The RSI did not make a new low, instead making a higher low and forming a positive divergence (line d).
The Fibonacci retracement analysis can provide some important insight during bear market rallies. Using the March high and the May low, the 38.2% retracement resistance was at 3840, with the 50% resistance at 4087. Once an initial level is overcome, then the next level is the next price target. A strong close above the 61.8% resistance (in this case at 4334) was needed to signal a positive change in trend.
By early June 2000, the 38.2% level (not shown) was overcome, and then on July 12, the Nasdaq Composite closed at 4099 which was above the 50% resistance level. On July 17, the market had a high of 4289, which was a rally of 40.9% from the May low. The first wave of selling resulted in a decline of 17.9% from the July high. The RSI dropped below support (line d), which was a sign the bear market rally was over.
Five days after the early August low, the RSI moved back above its WMA, which was again a positive sign. The ensuing 21% rebound lasted 17 days as it peaked on September 1. The Nasdaq Composite reversed to the downside the next day, as the RSI dropped back below its WMA.
This was the start of a prolonged decline that resulted in a low of 2251 on January 3, 2001 (not shown). This was a drop of 47.5% from the July 2000 high and decline over the whole bear market of 56.1%. This new low was 36% below the May 2000 low.
The most dramatic bear market of the last thirty years occurred in Japan, as the Nikkei 225 (NK225) peaked on December 29, 1989 at 38,950, and spent more than a decade in decline. By March of 2002, the Nikkei had reached a low of 7603. This was a decline of 80% from the 1989 high.
Sometimes, I find it helpful to look at weekly or daily charts on a close-only basis. This converts them into a line that connects the closes. This often clarifies the chart formations, which is important in helping one determine when a bear market rally has truly ended.
The first significant correction from the Nikkei’s December 1989 highest close of 38,916 (point a) ended in April 1990, as it made a low of 27,251 (point b) and then had a weekly lowest close of 29,279. Based on the highest and lowest closes, this was a decline of 24.7%. Using the closing levels, the 38.2% retracement level from the December highest close was 32,920. In the week ending June 8, the Nikkei closed at 32,993 (point c), but then turned downward, and two weeks later it closed at 31,695.
After a two week rally, the selling increased and the decline below the June low confirmed a new downtrend. The closing low on September 28 (point d) was 20,984. The bear market rebound from the lows surpassed the 38.2% resistance (not shown) in early March 1991.
On March 15, 1991, the rebound peaked with a closing high of 26,843, which was just below the 50% retracement resistance at 26,998. The weekly chart shows that the Nikkei traced out a flag formation (lines e and f), creating a clear trading range to watch. The formation was completed on June 7 as the Nikkei closed below support (see arrow).
Later this month, I will look at how Fibonacci analysis can be used to project downside targets once a bear market rally has ended. In the meantime, consider reading my examination of event-driven bear markets from a few weeks ago.
In my Viper ETF Report and the Viper Hot Stocks Report, I update subscribers with my market analysis at least twice a week, and more often when the markets are volatile. I give specific advice on the long and short side of the market, and I will be watching any market rebound closely.