We have been calling for the markets to make new lows for eight weeks. The new low occurred on Monday. Given the similarities to March 2008 that have surfaced since Monday’s low of 1,074 on the S&P 500, it is prudent to understand how sharp bear market rallies can be. The bear market rally off the March 2008 lows pushed the S&P 500 14% higher.
We have a list of 82 things to look for prior to a strong bear market rally. As of Wednesday’s close, 47 of the 82 things you would expect to see have occurred (or 57%). If that number moves higher in the next two days, it will increase the odds of a significant bear market rally occurring. We have said since August 12 that a bear market rally could carry us back to 1,260 on the S&P 500 – that possibility remains in play, which means we cannot ignore tight and prudent risk-management principals with our bearish/deflationary positions, which include shorts (SH), bonds (TLT), and the dollar (UUP).
The Europeans are stalling for time to get their house in order. Part of their strategy is to release statements when the markets get weak. Leaders know talk of bank recapitalizations can buy them some time, even if they do not have a plan in place yet. Recapitalizing the banks is a difficult and expensive problem. One example: If France uses public money to prop up bank reserves, they may get hit with a ratings downgrade. A downgrade would increase their cost of capital, which exacerbates their budget problems. It is difficult for nations with budget problems to allocate funds to banks. Should the money go to the banks or to prop up Greece? There is only so much bailout money to go around.
We have a prudent plan in place to step away from our shorts. As long as the market stays within the levels shown in the chart below, the market’s upside potential remains manageable relative to our shorts. We are preparing some client information relative to what we have seen that supports the possibility of a strong bear market rally.
Our concerns are not related to the end of the bear market or the start of a new bull market. The bias over the coming months remains down. We remain confident that stocks will make lower lows in the coming months. However, we must respect that bear market rallies can be strong and that they can last for several weeks (even 1 to 3 months).
Here are our comments from late last night:
The market is sending some mixed signals right now. The commodities markets are flashing deflationary/bearish signals similar to what we saw in August 2008. Stocks and all risk assets performed very poorly from August to November 2008.
The stock market looks very similar to an intermediate bear market low made in March 2008. Global stocks performed very well during the period March – May 2008. The S&P 500 rallied over 14%. The rally was retraced by 100% later in 2008, but 14% is a big move.
Yesterday’s 2nd chart: Click Here for S&P 500 Resistance Chart