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July 5, 2010

Bear Rally Imminent

For several weeks I've been pounding the table about the likelihood that the bear market has returned, and the evidence continues to pile up. Our first clue came in early May based on a certain behavior of the daily equity cycle. When the decline proceeded to take out the February yearly low, we had confirmation of a failed yearly cycle. With this evidence in hand, we can expect any rally to fail to take out the April high and for stock prices, bear market rallies notwithstanding, to work their way generally lower until the next yearly cycle low.

Various blogs were pointing at the divergence by tech stocks at taking out the February low as a sign stocks would return to new highs, but as we all know, non-confirmations can change, and so this one did.

Nasdaq 100 chart

Dow theorists also point to the fact that transports have yet to take out the February low as a sign the bull is still alive. But keep in mind that in Dow Theory, non-confirmation is not a signal. As with tech stocks, the transports may very well continue low and eventually confirm the return of the bear.

On the macroeconomic front, the weakness in the Baltic Dry Index continues to become more pronounced.

Baltic Dry Index

The rally in U.S. Treasuries is yet another red flag:

30-year Treasury chart

Despite the preponderance of bearish signals piling up, it is highly unlikely this market is going straight down. I expect this next phase of the bear to be much more vicious than the first in that, rather than a crash/liquidation event that disguises bears as geniuses, we will see rapid declines such as the April/May period followed by violent rallies that rob shorts of most of their profits. In fact, it seems one of those rallies is almost upon us. Public sentiment has become quite bearish, and the SPX is sitting right on top of a long-term pivot.

S&P 500 weekly chart

Given expectations for an impending rally that fails to set a new high, we can observe pivots on the daily scale to take a stab at how far the bounce may go:

S&P 500 chart

Such a rally would be typical for the reaction off the initial bear market decline and should generate enough bullish sentiment to setup the next decline.

One of the big beneficiaries from the return of the bear, in my opinion, will be gold. At some point the Fed is going to panic and juice up the printing presses again. In fact, based on the recent action in the buck, I wouldn't be surprised if they have already begun printing in stealth mode.

dollar index price chart

Unfortunately, it seems our politicians are intent on repeating the mistakes of the Great Depression. Economies simply cannot be centrally managed without creating larger inefficiencies and distortions than the ones the planners are trying to avoid. Let's just hope we can personally navigate these rough waters well enough to protect ourselves, and that someone in power will come to their senses before we have to suffer another major war to get ourselves out of the funk.


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