A reasonable percentage of my posts are about the market, partly because I enjoy it and partly because that is what seems to be consuming everyone these days. I noted in recent newsletter articles that the stock market agains appears to have found the bottom trendline of the channel it’s been in since October 2007. On a weekly chart, the Dow Jones Industrial Average (INDU) indeed seems to have bounced off the channel bottom. It now must test the 200-week simple moving average (SMA), which is at about 11,712:

Note first of all that the upper channel line is almost the same as the (now declining) 50-week SMA. If the market rises that far, it will be simultaneously testing that average and the upper trendline. The prospect of a breakthrough there is not great, as I have discussed. The gray circle on the upper trendline indicates a possible point of intersection for that test. But will the market even advance that far?

The INDU nudged the 200-week average not so long ago and has pulled back. I nevertheless expect a full-on test of the 200 soon, in large part because so many expect it to occur and because a convincing failure there has not yet occurred. If the INDU breaks above the 200, a further advance to test the 50-week average may reasonably be supposed.

The market may, however, pull back to again test the lower trendline, as it did in March, which is noted on the chart above by the green circle. Another leap at the upper trendline is therefore quite likely.

To date, the INDU’s intraday low of 10,827 this year represents nearly a 24% selloff from the intraday high of 14,198. Put differently, the Dow has in less than a year lost nearly a fourth off its all-time high level in October 2007.

A fair question, one on many minds: if the current market is a correction to a major uptrend, when will this correction be over? No one knows, and the technical factors - while helpful - ain’t the whole story. There’s inflation, the economy, and other factors discussed at length by me and many other commentators. I think more selloff is necessary would be necessary to convince everyone that the correction has bottomed - a clear point of capitulation needs to occur.

But truly resuming a new uptrend will require a healthier economy and stronger corporate earnings. Will they be there? If so, the question of whither the market answers itself.

I am bearish now, as most of you know, but the market will in coming months - say by the end of October - make clear whether it is merely correcting a major uptrend still in place or if more bear is to come. I think a resumption of the bull this year or early next year is quite likely, especially given the election. We’ll soon know.

Quick Historical Note:

1. The correction of 2000-02 retraced approximately 38.2%, then later hit 50%, of the rise from 1990. Both are Fibonacci retracement theory numbers. In fact, the Dow declined to previous market top (support) levels from 1998.

2. The current correction already has hit 38.2% of the rise from the bull market’s 2003 beginnings. In fact, the first week of July 2008 saw a fall to 10,827, which is a 50% retracement. The current correction has already hit 2005 support (the INDU’s 2005 top) and has almost hit the 10,752 top from early 2,000.

3. Also on a positive note, the 200-week SMA has not yet turned downward. That downturn will be negative news. should it occur.

Feel better now? I know one thing: the more bearish more people become, the better I feel.

For call writers, of course, all of this is merely an attempt to answer the question of when is best to write covered calls. Right now is good, since the market has hit a (probably) temporary bottom and is gathering for a spring at the upper trendline.

Important Note: If we get another pullback testing the lower trendline, as in March 2008, don’t panic. It is not unlikely. Today’s pullback may indicate a retest of the lower trendline or may just be noise. And don’t forget: we’re in the doldrums time of year, and a lot of traders are on vacation now or not working their hardest.

This post is a little longer than usual, but worth it for me to think things through, and - I hope - worth the read for you. Mark Hulberg, whose newsletter tracks the results of investing newsletters, recently noted that Richard Russell has now turned long-term bearish on the stock market. Russell - no spring chicken - is the editor of Dow Theory Letters, a newsletter distributed since 1958 and is the dean of stock market newsletter publishers. Hulberg interprets Russell’s analysis to be that the market’s long-term trendline has been violated and that the market is headed down until further notice.

While Mr. Russell (who is 84) is a formidable technical analyst, I tend to think this bear market is a correction to the stock market’s long-term uptrend. Let’s take a look at the Dow Jones Industrials (INDU) going back to 1994. We see a long-term uptrend that began in the late 1980s, sharply accelerating from late 1994 to the end of 1999. The bear market of 2000-2002 is clearly delineated and we can see a test of the 100-month moving average at the 2002 correction bottom; then the major uptrend resumes through October 2007.

The current market appears to be another major correction to the long-term uptrend. If so, we can reasonably expect the market to continue its oscillations within channels down to the long-term trendline, which also happens to be the 100-month moving average - right where the red circle is drawn.

Of course, when the market tested that average in 2002, the trend line could not have been drawn where it is now; since it is drawn across bottoms, the bottom must clearly have occurred in order to draw it. However, the test of the 100-month average did occur and the market passed the test.

Will the market find support again at the 100-month level (also roughly the trendline) at about the 10,500 level? The odds are good that it will, because at that point all the players except perhaps the public are ready for a reversal and help make it come about. In this view, we are not in a secular bear market, strictly speaking, but a major correction to the major trend. Ditto for the 2000-2002 bear market.

Points to ponder:

1) The market is testing the 50-month average now. While it could find support there and stage a major recovery, it seems unlikely, given the state of the economy, inflation, etc. As I recently noted in a newsletter issue, the market is at the bottom of a declining channel on a weekly chart and likely will rise to the upper channel line, a normal and expected (by me, at any rate) oscillation. Then it will almost certainly resume plumbing for the major trendline down about 10,500.

2) The 100-month average is going negative (curling over and pointing down). If the 50-month follows suit, expect a test of the 200-month.

3) If the market fails at the 100-month average, the next major INDU support level is at about 7,750, the 2002 correction bottom. That would be about a 45% selloff from the highest close at 14,164. By this I don’t mean a 45% retracement; it would mean a loss of nearly half the Dow’s value. That seems a little extreme. Possible, but not so likely.

The Retracement Perspective:

Retracement theory posits that a market, after a rise with no major correction, will correct - retrace - much of the move up. Many, including myself, rely on the Fibonacci sequence. In the early 2000s bear market, the market retraced almost a perfect 50%, as shown in the next chart.

A 50% retracement in the current bear movement (10,889) would take us almost to the 100-month average and the trendline. But heck, we almost hit that on July 15th. A trip down to the 7,750-level on the INDU would be a 100% retracement (they happen). The chart below demonstrates the Fibonacci levels for both the 1999 and 2007 peaks (the green line is the 100-month average again):

Note how much sharper the selloff has been this time than in the 2000-02 correction. The contrast is a bit unsettling. I think this market is ginning up a greater than 50% correction, since we almost touched that in July. At the very least, it will test the 100-month average. While anything could happen, there is no reason to think the correction is done. There simply is nothing to break the downtrend’s progress.

I’m in Palm Coast, Florida, for the week, though we have broadband and can get phone messages.