Wall Street is still overly optimistic even after the Dow Jones Industrial Average’s DJIA.
Drop of more than 500 points on Wednesday after the last meeting of the Federal Reserve and the rate hike.
Consider all the attention given to a possible ‘double bottom’. By framing the market’s weakness in this way, the bulls are trying to put a positive spin on the market’s decline – which has already lowered 12% of the S&P 500 SPX,
since the mid-August highs and 15% off the Nasdaq Composite COMP,
A double bottom occurs when the market forms an initial low, rises for a while, then falls back to that initial low but does not fall significantly lower, and then begins a significant new leg. Of course, it would be good news if the market followed this script. But there is no way to know in advance.
The remarks about false bottoms made by Robert Edwards and John Magee, authors of the Bible on technical analysis, entitled “Technical Analysis of Stock Trends,” are telling. They write that double bottoms (along with double tops, the functional equivalent of the bull market) “may be referred to by name more often than any other chart pattern by traders who have a bit of technical ‘lingo’, but little organized knowledge of technical facts… . [True] Double bottoms are extremely rare… And the real patterns can rarely be positively detected until prices are quite far from them. They can never be predicted or identified once they occur, based only on map data.
Given this, the recent wave of attention to double bottoms suggests that we are still early in the process through the five stages of bear market mourning I discussed earlier – denial, anger, bargaining, depression and acceptance. Celebrating a market decline as setting up a bullish double-bottom formation indicates that we are not beyond the “negotiation stage” – with depression and acceptance to come.
As Edwards and Magee note, charting alone does not help predict whether the market’s second downturn will end at the same level as the lows of the initial drop. But are there non-map factors that give us valuable straws in the wind? To gain insight, I reached out to Hayes Martin (chairman of the consulting firm Market Extremes) and David Aronson (a statistician who has written several books on how to base your investment decisions on a solid statistical foundation, including evidence-based technical analysis ).
On the one hand, they both told me that the factors that indicate a healthy or sick market are the same today as they would be any other time. For example, extreme bearish sentiment is a good indication that a decline may soon give way to at least some sort of rally, regardless of when it occurs. Martin says that while there is a significant degree of bearishness among investors and advisors right now, he shouldn’t expect a major low until there is a “further spike in negative sentiment.”
This ties in with my column earlier this week on the absence of investor capitulation—the widespread desperation that drives investors to throw in the towel and renounce stocks altogether.
On the other hand, Aronson added, there are factors to watch out for that are unique to the market’s decline to the area of its initial low. For example, during that second decline, it would be bullish if significant differences arise in the behavior of different market sectors and market averages. This would happen if only a few sectors and averages fell below their initial lows, while others remained well above their levels.
According to Martin, only a “modest” number of such differences have emerged so far. Coupled with the lack of a spike in negative sentiment, it would be premature to predict that the market’s decline will end near the June lows.
Things may change in the coming days as market conditions change quickly. If significant divergences emerge, coupled with a spike in negative sentiment, “the bottom will be all the more powerful,” Martin said. In the meantime, don’t jump on the gun.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings keeps investment newsletters that pay a fixed fee to be audited. He can be reached at [email protected]
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