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.

This entry was posted on Tuesday, August 5th, 2008 at 9:20 am and is filed under Markets/Economy, Technical Analysis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.