There’s a Bear Lurking Out There Somewhere

The bull market is almost 5 years old, and many analysts are wondering just how much longer it can continue without a major correction

ALEX ROSLIN
SPECIAL TO THE GAZETTE
The Montreal Gazette
Monday, May 14, 2007

The major stock indexes have shrugged off their winter blahs and zoomed off into the cosmos. The S&P 500 is testing its 2000 dot-com highs. The S&P/TSX composite index has been shooting to new record highs since last fall, closing at yet another high of 14,003.8 on Friday.

Last Monday, the Dow Jones industrial average recorded its longest winning streak in 80 years, matching its 1927 record of 24 up days in 27 sessions.

The gains have surprised much of Wall St., where gloomy sentiment has been all the rage since last summer’s nasty correction. Analysts are wringing their hands about just how far the nearly 5-year-old bull market can creep without a major correction.

Ominous comparisons are being made with the bubbles of the late 1920s, late 1980s and late 1990s, which led to the spectacular crashes of 1929, 1987 and 2000.

“(The 1987) time period, as well as the chart pattern from back then, matches up pretty good with today’s action,” said Marc Arbeter, chief technical strategist for Standard & Poor’s Equity Research, in a Business Week magazine story in late April.

“We stand in awe of the sheer majesty of this rise,” said analyst Dennis Gartman in his influential Gartman Letter in early May.

Gartman compared the current bull to the four-fold rise of Japan’s Nikkei index from 1984 to 1989, which led to an 80-percent correction that took 14 years to finally end.

“It will stop suddenly,” he wrote. “It will end in tears, but it can and likely shall continue to move higher nonetheless.”

Some analysts say the very fact that Wall St. is so fretful is actually a plus for equities. The explanation for this contrarian thinking comes from a couple of old trader’s dictums: Markets like to climb a wall of worry. And the crowd is usually wrong at market tops and bottoms.

When everyone gets highly optimistic, it’s often a sign that a speculative bubble is about to burst and a good time to sell. On the other hand, when everyone is super-negative, it often means there’s been excessive market panic—a good time to buy.

The current nervousness suggests the top isn’t in yet because investors have yet to become excessively speculative, said Philip Roth, chief market technician at institutional securities firm Miller Tabak in New York.

Today’s bullishness is nowhere near the levels seen in episodes like 1987, said Roth, who addressed a meeting of technical analysts in Montreal last week. (Technical analysis is the study of market chart patterns.)

“There has been much more bearishness of analysts during this whole bull market. That’s because they were hit on the head after the last bull market,” he said in an interview.

“It’s something like 1987, but there are differences. I think we are vulnerable to a very extensive correction, but I just don’t think we are vulnerable to that kind of plunge.”

Ron Meisels, a Montreal-based technical analyst, also thinks the bull may have further to run.

“This is a remarkable performance for an aging bull market,” he wrote in his newsletter last week.

Meisels noted that the bull, which started in 2002, is in its fifth year and getting old in the tooth.

“If this truly is a five-year market cycle, then the second half of 2007 is shaping up as a very ominous period for the bulls. The ‘light at the end of the tunnel’ will likely be the oncoming train marked BEAR,” he said.

What has many analysts scratching their heads is the fact that the market has gone a year without a serious tumble.

Much of Wall St. expected a major correction would start last fall. The autumn is typically the weakest period for the markets, and last fall was expected to be especially harsh because it was also the mid-term year of the U.S. president’s four-year term in office.

The Stock Trader’s Almanac has found that markets tend to bottom every four years or so, most often during the mid-term year of the presidential term.

Concerns about a crash last year were so prevalent that small traders stood at record levels of bearishness through most of last summer and fall, as measured by their positioning in S&P 500 futures and options as reported to the U.S. Commodity Futures Trading Commission.

Meanwhile, the markets kept climbing with no significant selloff, except for a small hiccup in February and March that stocks quickly shrugged off.

And yet, while the markets rallied, small traders in April again had historically extreme levels of bearish positioning in S&P 500 futures and options.

The same thing was happening in the tech-heavy NASDAQ composite index. In March and April, large investment firms and hedge funds stood at historic extremes of bearishness in NASDAQ futures and options.

When the investment funds and small traders get super-bearish, it has historically meant the markets are likely to go up.

That’s because the big investment funds and small traders tend to be positioned the wrong way at key market turns.

Meisels sees the possibility of some “minor selling” this spring, followed by a summer rally, then a “blowoff” probably in September or October, leading to a 15-percent correction.

Roth agreed. He said the lack of a selloff last fall means the expected plunge may just have been postponed to this spring or fall.

When it comes, he predicts an “average” correction—six to nine months in length, with a downside of 20 to 25 percent—“not a killer bear.”

[Accompanying charts published with this story showed the NASDAQ's 28-percent climb since last summer, the NASDAQ's languishing compared to the Dow Jones industrial average, the recent breakdown in crude oil's uptrend and the VIX Volatility Index, which shows market complacency hasn't declined to the lows of last winter.]