Bear Market Rally Update

The S&P on Friday proved out my hunch about a quick move to the 1010-1020 range, hitting 1018. What happens now will be interesting. I had been calling for a blow-off 5th-of-5th wave top, but today's action has ruled out that scenario. I present the (inviable) count of the 5th-of-5th wave here:

The 5th-of-5th scenario, while problematic in that internally I had trouble breaking down the waves, was the "cheerier" scenario. It assumed a 5-3-5 C wave starting from July 8th to complete the bear market rally, the first third of which would have ended today. Under that scenario, maybe we'd correct from here to the 50-day moving average and then bounce back to new recovery highs. Instead, I'm looking at the possibility that the C wave from July 8th was really a combination three, with a zigzag A and a triangle C, and moreover the entire wave ended Friday. Friday's action certainly had the feel of an ending move: 25+ points, from 992 to 1018, in the space of 24 hours. It felt like a blow-off top, killing any bears that were left in the market. (Not us though: our QID survived the onslaught—another telling sign since Nasdaq again failed to follow the Dow/S&P in achieving new highs.) Here is a chart of that potential count:

This is all to anticipate, since we haven't even gotten confirmation that Friday's high was a top of any degree. For example, a higher high Monday (or indeed, anytime over the next year or two) would rule out all this speculation. Nevertheless, many now claim that a new bull market has begun. Looking at the big picture, that does not appear to be the case. Against the backdrop of the entire crash, the "strong" rally from March actually looks a bit weak: not a lot of upside given the amount of time it had. In 5 months it rose 350 points; meanwhile, the S&P fell by a greater number in less than a month between the end of September and the beginning of October '08. For this uptrend to continue, the market would have to turn parabolic as happened in mid-April when a rising wedge resolved to the upside. Meanwhile, the entire recovery rally from March has been forming a large rising wedge, the top of which was scraped Friday.

Note the overbought reading on the RSI late July and into this month, the first such occurrence in 2 years, with a potential negative divergence forming. There are other ominous signals. 1014, hit Friday, was a magic number: the 38.2% retracement of the decline from October 07 through March 06. That is the minimum retracement expected for the recovery rally, meaning it's possible we've seen the high for the foreseeable future. If that's the case, the recovery rally looks foreshortened. Such a long A wave, and a C wave half its length. In terms of time, however, 5 months was the duration of the 1929-1930 bear market rally, the last such bear market rally of the degree we're experiencing, and we hit the 5-month mark Thursday. Seeking Alpha features an article with a graphic overlaying the current rally with the one from 1929, claiming an 80% correlation, and it's worth checking out. The 1929 bear market rally had the reverse characteristics in that it had a quick A wave and a lengthy C wave (but the same relentless upward drive):

In the above chart, the 1929-1930 rally doesn't look like it's over, and even 1.5 months later it looks like it's in healthy shape:

But really, it was the prelude to one of the most devastating declines ever to hit the stock market, as the C wave lasted for 2 years and the DJIA dropped over 80%: Clearly the stakes are high. I could be completely wrong about this rally; it could be the start of a new bull market. But to be on the safe side, if you have money in a retirement account, I suggest liquidating into cash/money market out of stocks/mutual funds next week. Same thing for long-term investments. Meanwhile, later this weekend I'll post my trade ideas for Monday. They will mostly be short candidates, but I'll offer at least one long in case I'm off the mark about where the market is right now.

UPDATE: After playing around a bit more with the counts, I found a count that better addresses the problems of proportionality and frankly doesn't look quite so odd. Under this scenario, we're still a week or two away from the peak of the rally. First we'll get a fast move down, followed by a final move up to new recovery highs in the 1025-1050 range. A hypothetical illustration appears below.