What-if scenarios do not a bear stock market make

The Nasdaq gapped down 38 on the open last week. I know, for once in my life, I was there to see it. Yes, when you watch the Fast Money show and see the folks walking by at Times Square, I was at that window right at the open to see the number change right on the open. It was also 15 degrees out there. Lots of great things happened on this trip to the Big Apple and one not so great thing. About 2 hours after my presentation I came down with a touch of the flu. Consequently, I think I missed my first column altogether in about 3 years. But it was a very important week.

First of all, the drop was blamed on the new Libya crisis. Once again we are looking at a fear situation coming off a high. I can think of only one situation in the past 80 years where a move off a high based on fear ended up accelerating lower. In a normal market, fear levels rise at market lows, not highs. The market peaked 2 weeks after Hitler invaded Poland which means that the scariest event of 1939 did not top out the market. Do you know what that was?

It was the Hitler/Stalin Pact and the start of WWII several days later. For those of you who don’t know, that agreement by sworn enemies took the world by surprise. Nobody expected it. Look at the chart you’ll see a gap up. The spike down was Friday, September 1. That was the day the market bottomed. It was Labor Day weekend I would imagine because the markets reopened on Tuesday September 5. Remember that Great Britain declared war on Hitler on September 3. That was obviously viewed as good news but markets topped a week later. What was the good news that hit on September 15? Was that the day it became obvious that Poland would fall. That obviously wouldn’t be good news. From that point markets began a slow descent until May of the following year when the Phony War ended and the 6th Army (among others) marched across Western Europe.

Why are we having this history lesson today? In 1939 markets reacted to very tangible bad news. Today they are only hypothesizing on a bunch of ‘what if’ scenarios. What if the oil isn’t there? What if Saudi Arabia is next? We don’t know any of these outcomes. So I think the emotional reaction is more than likely an excuse to take profits in an already extended market. I monitor certain chat rooms and the ultra bears are absolutely convinced the 2 year bull market is over. Odds are one of these times they are going to be right. I happen to think the time they will be correct will be the time it won’t be so obvious.

By the way, when France fell the market BOTTOMED. France was invaded on May 10, that was the day the C wave kicked for a parabolic drop. The Dow opened at 148.20 and bottomed on June 10 at 110.40 which is a 25% drop in a month. Paris was occupied on June 14 and the French waved the white flag on June 17. From there the Dow started a 5 month bear market rally.

Do you see where I’m going with all of this? Bull and bear markets operate very differently. Think back to our own bear market. From October 2007 it was at least 8 months before the Fed admitted there was a serious problem. We were told over and over the sub prime mess was contained and all would be well. In developing bears there appears to be a period of complacency, denial and slide down that slope of hope while convincing themselves things will be better if not just fine. I told you in a previous post that bull market corrections end when fear levels get thick. That could take 1000 days, 100 days or in the case of Egypt, a single day.

So the only real example of fear building upon itself that drove markets lower was WWII. That was a once in a generation type of event. The obvious question here is are we dealing with a normal market or a generational event? The correct answer is you go with the higher probability until the weight of the evidence starts to shift. That’s why we have to look to the pattern to guide us. In this situation the SPX peaked out nearly 20 points above our 1325 bear market 3rd rail and the BKX fell 3 points shy of its nearly 59 high last April. I told you that before we can get long term bullish we needed to see the SPX survive and start to build a base at 1325 or higher and we need the BKX to take out the April peak from last year. We don’t want 1 out of 2. We need 2 out of 2 on this one.

That hasn’t happened yet. What has happened is an orderly move to important near term support lines on most charts. They’ve come to the logical place where you’d expect a bounce and on Friday they started bouncing. It’s all good. Or is it?

First of all it’s important to understand why the market turned when it did. No, it wasn’t because of Libya. If you believe that and trade on news events, one day you will not have a bankroll to trade these markets. For every time you think you get it right there will 3 or 4 times where you don’t. So what do I think is the reason for the turn? The best reason I can gather is markets peaked around the 161 trading day window to the July lows from last year. That would make this new pattern an intermediate level correction at worst. If any of these indices hit a new high this view will have been proven to be the correct one.

That doesn’t mean I think markets are going right back up. Market psychology is really complicated right now. While there is fear at the high there is relief at the low. There was one sequence that told me more about the state of the market than anything else last week. If you were watching CNBC a rumor was floated that Gaddaffi was shot and possibly killed. Think of how you would have felt if you heard that news. If you are like most people you probably felt relief. That’s the problem. Markets started rallying after that news came out. Markets are supposed to top on good news and bottom on bad news. Now we have the opposite materializing. It doesn’t matter that Gaddaffi wasn’t killed; it’s the idea that he might have been that is most telling in this instance. So when you consider the 161 day cycle, the move to support and market psychology it adds up to the potential of a complex corrective pattern developing. But it’s not likely the end of the bull market.

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