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The Market Is At A Crossroads

 April 04, 2009 11:38 AM

There are signs of both a potential market recovery (the beginning of a larger bull rally), and signs that this recent 20%+ run-up was nothing more than a bear market rally.

The good news is that there will be plenty of opportunities going forward, regardless of which of the above scenarios plays out.

Bull Market Rally Scenario

The move that we have recently seen, i.e., 24.82% in the Dow Jones Industrial Average ($DJI), 26.82% in the S&P 500 (SPX), and 28.26% in the Nasdaq (COMP), from the lows made in early March to the highs made just 4 weeks later, suggests a larger move could be in store.

For one, it's generally believed that a 20% rise in the stock market, marks the beginning of a bull market. Likewise, a -20% decline in the stock market, signals the start of a bear market.

Secondly, the market had become terribly oversold (by Mar 6). You can see this on many technical oscillators such as the Relative Strength Index. (See the chart below.)

S&P 500 Index

- close as of Thursday, Mar 2, 2009

It can also be quantified by the sheer number of new 52-week lows that were made in individual stocks while the market indexes were making new lows. In fact, each successive major new low made in the market (S&P 500: 839.80 on Mar 10 2008, 741.02 on Nov 21 2008 and 666.76 on Mar 6 2009), brought with it fewer new individual 52-week lows each time, with the difference being in the thousands between the last lows in March 2009 and the 'first lows' in October 2008.

This shows the market has either gotten ahead of itself or that perhaps too much value has been stripped out of the market. Either way, the market indexes are simply a composite of individual stocks. And if fewer and fewer stocks are able to make new low, an upside test ultimately has to take place.

Thirdly, the major indexes are all trading above their shorter-term moving averages (10- and 20-day) and medium-term moving average (50-day).

This clearly shows the market's recent momentum has turned positive.

S&P 500 Index

- close as of Thursday, Mar 2, 2009

And fourthly, on the fundamental front, there has been a steady stream of massive initiatives aimed at getting the financial sector and the broader economy moving again. The markets have reacted to these new developments, such as the second stimulus, the buying up of toxic assets and the purchase of US Treasuries.

In addition, the Financial Accounting Standards Board (FASB) also made their long awaited decision on mark-to-market accounting for mortgage backed assets to something closer to "significant judgment" when valuing these assets.

Combine this massive action from the U.S. with other significant steps taken from countries all around the world, and the market seems to be in a 'let's see if this will work' mode.

Plus, recent earnings have come out better than expected on many companies (not necessarily stellar, but not as bad as feared) suggesting that maybe things have stopped getting worse, or at least the pace at which thing have been getting worse has slowed.

Who knows if this is THE BOTTOM or just a bottom. If it is THE BOTTOM, then statistics show that a much larger move is in store. In fact, in a study of the Top 10 Worst Bear Markets since 1929 (using the Dow Jones), the average increase within one year of the lows was +55.62%.

I don't want to get ahead of myself, but the 3-year increase is +77.56%. And the 5-year increase is +103.41%.

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