If the market passes this upcoming test, the stocks will be able to move higher.  We’re not there yet.

If the market passes this upcoming test, the stocks will be able to move higher. We’re not there yet.

Wall Street is still too bullish, even after the Dow Jones Industrial Average DJIA,
-1.70%
Dropped 500+ points on Wednesday after the latest Federal Reserve meeting and rate hike.

Think of all the attention given to “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 cut 12% of the S&P 500 SPX,
-1.71%
from the mid-August highs and 15% off the Nasdaq Composite COMP,
-1.79%.

A double bottom occurs when the market forms an initial low, rallies for a while, then falls back to that initial low but doesn’t fall much lower, and then begins a new big move up. It would of course be good news if the market followed this script. But there is no way to know in advance.

The observations about double bottoms made by Robert Edwards and John Magee, authors of the technical analysis bible called “Technical Analysis of Stock Trends,” are telling. They write that double bottoms (along with double tops, the functional equivalent in the bull market) are referred to by name perhaps more often than any other chart pattern by traders with technical ‘lingo’ but little organized knowledge of technical facts… . [True] Double bottoms are extremely rare… And the true patterns are rarely positively detected until prices have gone far away from them. They cannot be predicted, or recognized as soon as they occur, from chart data alone.”

Because of this, the recent increase in attention to double bottoms suggests that we are still moving early through the five stages of bear market grief that I discussed earlier – Denial, Anger, Bargaining, Depression and Acceptance . When a market decline is celebrated as the formation of a bullish double bottom, it is clear that we are not beyond the “Bargaining” phase – with Depression and Acceptance still to come.

Bottom fishing

As Edwards and Magee point out, chart formation alone is of little help in predicting whether a second down market wave will end at the same level as the lows associated with the initial decline. But are there non-charter factors that give us valuable straws in the wind? For insight, I contacted Hayes Martin (president of consulting firm Market Extremes) and David Aronson (a statistician who has written several books on how to base your investment decisions on a sound statistical foundation, including Technical Analysis Based on Evidence) .

On the one hand, both told me, the factors that indicate a healthy or sick market are the same today as at any other time. For example, a wave of bearish sentiment is a good sign that at least some sort of rally may soon taper off, regardless of when it happens. Martin says that while there is a significant amount of bearishness among investors and advisors right now, he wouldn’t expect a major low until “there is a further spike in negative sentiment.”

This is in line with my column earlier this week on investor undercapitalization – the widespread desperation that is causing investors to throw in the towel and swear off equities altogether.

On the other hand, Aronson added, there are factors to watch out for that are unique to the market’s descent into the area where it is low. For example, during that second passage it would be bullish if significant differences emerged in the behavior of different market sectors and the market average. This would occur if only some sectors and averages fell below the initial minimums while others remained significantly higher.

So far, Martin says, only a “moderate” amount of such variations have emerged. Coupled with the lack of a spike in negative sentiment, it would be too early to predict that the market’s decline will end in the vicinity of its June lows.

Things could change in the coming days, as market conditions change rapidly. If significant differences emerge, along with a spike in negative sentiment, “the bottom line will be more powerful,” according to Martin. In the meantime, don’t jump the gun.

Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that pay a flat fee to audit. It can be reached at marc@hulbertratings.com

More: Stock buyers are still too supportive of an end to the bear market

Plus: Ray Dalio says stocks, bonds to fall more, sees US recession coming in 2023 or 2024

Leave a Reply

Your email address will not be published.