2011: Major market bottom or continuation of ’09 bull? rally

Here are my thoughts on where we are in regard to the bull market cycle.  Remember, this and $3 will get you a cup of coffee.

Looking at a weekly chart dating back to 2009, visually it appears the most recent follow-through rally is simply a continuation of the 2009 bull market and not the start of a new bull.

1. We didn’t undercut the 2010 summer doldrums in 2011, so by that measure we didn’t reset the rally clock back to zero.
2. Given how powerful the 100%+ rally since the March ’09 bottom has been, a 20% decline in 2011 is kind of smallish given the scale of the rest of the move.
3. And lastly, the 2011 sell-off was a panic-driven, single-leg down that lasted just a couple weeks before finding a bottom.  In comparison, most major market bottoms are a reversal after prolonged declines comprised of multiple legs down.  In that context, it seems the recent rally is nothing more than a rebound from the panic induced selling last summer that turned out unjustified.

Using this context, if we were labeling things, we might call the Summer of 2011 an abrupt correction and not a full-on bear market.  It also appears to be a continuation pattern for the 2009 Bull.  But semantics are semantics and hopefully we don’t care nearly as much about labels as we do about anticipating future price action.

Now this is moving into soft science along the lines of reading tealeaves, but it looks like we could be in the 5th wave of an Elliott Wave.  (You can find good  information on Elliot Waves on Wikipedia.)

Why this is important is if we really are in wave five, that potentially means the next wave will be the start of the three-wave counter trend.  Paraphrasing W. O’Niel, if we get the direction of the market wrong, then most everything else we do will be wrong too.

Elliott Wave Theory is built on human psychology and shows up time and time again, but it is hard to use for timing trades because placing wave lines in real time is highly subjective.  In reality, it is a big picture tool to use occasionally to put market moves in perspective and it is most useful for reinforcing other ideas you are seeing.

Here is a second chart of the last few years with intermediate waves drawn on the chart showing the a smaller Elliott Wave pattern within each of the primary waves.  These patterns show up all the time, but the thing to be careful of is our natural tendencies to see patterns even when none exist.  But the intermediate waves seem to fit Elliot Wave Theory like a glove with their 5 waves up and 3 waves down.

Based on other signals in the market and economy, I don’t see a material corrective trend in our near future and this wave 5 still has a bit more room to run.  Maybe next year if economic growth pauses, that will provide the catalyst for a corrective trend.  But the two important things I do see happening due to the age of the bull is the rate of gains made in the markets will start to taper off as the bull gets older. And as part of this, we might see less correlation among stocks, making this the first time in years where stock picking has been important.  Over the past 4 years, you could have made a bunch of money (or lost a bunch of money) simply by owning any random stock.  Now we are getting to a place where simply holding random stocks will not give you the same bang for the buck and quality will start mattering again.  (recent gains in AAPL and other leaders are impressive, but pale in comparison to the 100% moves seen in broken names like SHLD, BAC and NFLX)

We just can’t keep up the pace of broad market gains we saw in 2009 and 2010.  After we reach a higher level of complacency, I expect we’ll see the corrective trend.  But this will still be part of a larger decade long secular bull market we started back in 2009, so view most pullbacks as buying opportunities.  And if you have a buy-and-hold portfolio, have the courage to hold through the dips.