There is still too much upside on Wall Street, even behind the Dow Jones Industrial Average
DJIA,
A drop of 500+ points Wednesday after the last Federal Reserve meeting and rate hike.
Think of all the attention given to a possible “double bottom.” By outlining the market’s weakness in this way, the bulls are trying to put a positive spin on the market’s decline – which has already been cut 12% off the S&P 500
SPX,
from mid-August highs and 15% of the Nasdaq Composite
comp,
A double bottom occurs when the market forms an initial bottom, rises for a while, then moves back to that initial bottom but does not fall significantly lower, and then begins a serious new leg up. Of course, it would be good news if the market followed this scenario. But we have no way of knowing in advance.
The comments on double bottoms made by Robert Edwards and John Magee, authors of the technical analysis bible entitled Technical Analysis of Stock Market Trends, are eloquent. They write that double bottoms (along with double tops, the functional equivalent of a bull market) are “called by name perhaps more often than any other chart pattern by traders who possess little technical ‘jargon’ but little organized knowledge of the technical facts… . [True] Double bottoms are extremely rare… And true patterns can rarely be positively detected until prices have moved well away from them. They can never be predicted or identified as soon as they appear from chart data alone.
That being said, the recent surge in attention to double bottoms suggests that we are still early in progressing through the five stages of bear market grief that I have discussed before — Denial, Anger, Bargaining, Depression and Acceptance. Celebrating a decline in the market as the creation of a bullish double bottom formation indicates that we are no further than the “deal” stage — with depression and acceptance still to come.
Bottom fishing
As Edwards and Magee point out, chart formation alone is not very helpful in predicting whether the market’s second wave down will end at the same level as the lows of its initial decline. But are there factors outside of the chart that provide us with valuable straws in the wind? To gain insight, I reached out to Hayes Martin (president of the consulting firm Market Extremes) and David Aronson (a statistician who has authored several books on how to base your investment decisions on a solid statistical foundation, including Evidence-based technical analysis).
For one thing, both told me, the factors that indicate a healthy or sick market are the same today as at any time. For example, an extreme in bearish sentiment is a good indication that a decline may soon give way to at least some kind of rally, regardless of when that may occur. Martin says that while there is currently a significant amount of bearish sentiment among investors and advisers, he would not expect a significant bottom until there is “an additional spike in negative sentiment.”
This coincides with my column earlier this week on the lack of investor capitulation – the widespread desperation that is causing investors to throw in the towel and swear off stocks entirely.
On the other hand, Aronson added, there are factors to watch for that are unique to the market’s descent into its first trough. For example, during this second descent, it would be bullish if significant differences in the behavior of various market sectors and market averages occur. This would happen if only some sectors and averages fall below their initial lows, but others remain well above them.
So far, Martin says, only “modest” amounts of such differences have developed. Coupled with the lack of a surge in negative sentiment, it would be premature to predict that the market’s decline will end near the bottom in June.
Things may change in the coming days as market conditions change rapidly. If significant divergence occurs, combined with a spike in negative sentiment, “the bottom will be even more powerful,” according to Martin. Meanwhile, do not drop the weapon.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
More ▼: Scurrent buyers are still too bullish for the bear market to end
plus: Ray Dalio says stocks, bonds still to fall, sees US recession in 2023 or 2024.