Thursday, March 13, 2008

Is The Market Setting Up for a Huge Rally?

News flash: It appears I am not entirely alone in seeing the potential for a big rally in the stock market. Correspondent Chuck D. notified me that analyst Robin Landry came to a similar conclusion via Elliott Wave analysis (he saw the reference over on Deflationist analyst Rick Ackerman also came to the same conclusion today. So stay tuned!

Ever the contrarian, I look at charts and wonder: is the market setting for a huge rally that will decapitate all the supremely confident Bears?

Yes, we all know the economy is sliding into recession, and very likely a deep, prolonged one; that oil is $109 and heading who knows how high; that the credit bubble has popped; that the dollar continues downward in what looks like a death spiral; that trillions in derivatives are poised to tumble into the abyss--the list of ailments is so long that we wonder why the patient hasn't just expired from exhaustion.

I brought up the possibility of a real rally on January 30--not just a one or two-day short covering blip, but the real deal: We Told Ya So--But So What?

In the face of overwhelming evidence that the stock markets should fall another 30%, or perhaps 50%, why do I persist in looking for the chimera of a rally?

Reason 1: legendary stock trader Jesse Livermore observed that market rallies take along the fewest possible traders. If there was ever a time in the past six years when doom and gloom was triumphing and Bulls were as a scarce as U.S. politicians' offspring in Iraq, this is it. If the market were to rally in the face of such sustained bad news, it would surely be taking along the fewest possible number of Bulls.

For more from Jesse, please read the classic Reminiscences of a Stock Operator.

Reason 2: There is a big divergence between price and MACD. As we can see on this chart of the NASDAQ, the last time such a divergence appeared, and the index was in the "Bear market territory" below the 200-day moving average, the divergence was followed by a sustained monster rally.

Now we all see the prominent "head and shoulders" pattern which generally indicates a top; but there is no technical reason why the index could not rise back up to the shoulder level--about a 20% rise from this week's low. (Levels of support-resistance are noted, as is a nice gap just below 2,600 which is begging to get filled.)

Were such a rise to follow an A-B-C-D pattern, or Elliott Wave pattern, there would be plenty of opportunities for Bears to short the uptrend and then be crushed by the next catapult up.
Regardless of whether it is the Bulls or the Bears, supreme confidence in the trend has often marked the start of a reversal. As I have yet to find anyone brave/dumb enough to announce this is a great time to buy into the coming monster rally, it seems entirely logical that such a rally is increasingly likely.

Then there's my own dictim: if it were easy, we'd all be millionaires. Shorting the market because all the news is horrific is just too easy; the market is set up to take your money, not hand you easy winnings.

Reason 3: If the markets had truly absorbed the full measure of the financial unraveling, the Nasdaq should be at 1,100 and the Dow Jones Industrial Average should be at 6,000. The fact that the markets are this resiliant suggests that there is plenty enough faith/denial/manipulation/greed or whatever other terms you wish to invoke for a major counter rally lasting months.

Remember, the markets do not respond to fundamentals; that has always been an illusion. The markets respond to price, volume and traders' psychology.

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