By: Tim_Wood
According to Dow theory, both bull and bear markets have three phases. Between
each of these phases there are important counter-trend moves. Our Dow theory
founding fathers explained that these counter-trend moves are misleading and
tend to be taken as a continuation of the previous long-term secular trend.
Based on the longer-term phasing and value aspects of Dow theory, the evidence
continues to suggest that the last great bull market began at the December 1974
low and peaked in October 2007. This data also continues to suggest that the
decline into the March 2009 low was merely the Phase I decline and that the
rally out of the March 2009 low serves to separate Phase I from Phase II of a
much longer-term secular bear market.
That's right, the rally out of the March 2009 low was not a new bull market
or a continuation of the previous long-term secular bull market. Rather, it is
part of a correction within a much longer-term secular bear market that began at
the 2007 top. In fact, based on my longer-term bull and bear market relationship
studies and other historical characteristics, the evidence suggests that once
the rally out of the 2009 low has run its course, the Phase II decline should
prove to be far more devastating than the Phase I decline. Therefore, from a
longer-term perspective I remain very bearish.
More recently, on August 4th both the Industrials and the Transports closed
below their March 2011 secondary low points. As a result, a Dow theory trend
change occurred and since this is the first such trend change since the rally
out of the March 2009 low began, we cannot take this development lightly.
However, history shows that not all Dow theory trend changes are ominous and
based on other technical data, there is a very good chance that the rally out of
the March 2009 low has not yet run its course. If not, the rally separating
Phase I from Phase II is not yet over. The details of these other technical
studies are covered in the monthly research letters. Point being, the market is
currently doing a bit of a technical high wire act in that while we do have a
Dow theory trend change in place, on the other hand there is also other data
that is actually still rather bullish and that suggests a higher level low is
being made. This may or may not change and as a technician the key is to monitor
the ongoing structural and statistical developments.
Based on the prevailing consensus, the current pessimism actually makes
perfect sense. As a rule, the market does what it has to in order to confuse the
most people. Ever since the decline into August began, it seems that the
consensus has turned rather bearish. In fact, I personally know of no one that
genuinely believes a move back above the May 2011 high is possible and maybe it
isn't. But, I do find it very interesting that such bearishness is being seen in
conjunction with such inconclusive technical data. As a result, it seems that
the most confusing thing the market could do is to continue to rally.
I have again included the chart of the 1966 to 1974 bear market period below
for comparison. The decline into the 1966 low marked the Phase I decline of the
1966 to 1974 secular bear market. This decline appears to be synonymous with the
decline into the 2009 low. The rally separating Phase I from Phase II of the
1966 to 1974 bear market carried price up some 26 months into the 1968 top. I
continue to believe that the rally out of the March 2009 low is synonymous with
the rally into the 1968 top. Once all of the technical factors are in place I
look for the fallout to be much the same as was seen following the 1968 top. I
realize that the same old message and comparison is not exciting or sexy. But,
the message of the market it is what it is as the bear continues to confuse the
masses. Once the technical DNA Markers are all in place, the Phase II decline
should get very very nasty. In the meantime, it currently appears that a much
larger trap is likely being set.
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