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Is the Bull Market Back?


A look at our four scenarios for the fourth quarter and what it may mean for 2010.


In September I outlined Four Scenarios for the Fourth Quarter that I hoped would unfold and help provide a bit more clarity for the longer-term technical big picture based on DeMark indicators.

There were basically four scenarios I was looking at as possibilities, all providing some important long-term context to the market. Before we get to them, let's look back and add some context to our present juncture. Below are this decade's returns for various global stock market indexes in local currencies (since January 1, 2000, and as of December 24, 2009):

  • DJIA: -8.96%
  • SPX: -23.7%
  • CCMP: -44.2%
  • FTSE100: -22%
  • DAX: -14.3%
  • NIKKEI: -44.3%
  • HANG SENG: +26.8%

Annualize those and you'll see that even the outlier winner -- the Hang Seng -- was a miserable performer when accounting for the risk of owning equities.

The reason to keep this in mind is because it highlights a very important point -- we've had a pretty severe global bear market in major stock indexes over the past 10 years. So the question is, what comes next?

Well, that's why I'm following the long-term quarterly charts with such interest. Just as bulls were ebullient at the top, trying to squeeze every last drop of gain out of the indexes, convinced in their herd-driven certitude we have likely reached a permanently high plateau, so too will bears at the bottom over-reach, convinced that the stock market will never again recapture old highs, dogmatic in the belief that some looming crisis will forever dampen equity indexes.

Neither will be correct. The answer is always somewhere in between, and since I have no idea what that in-between answer will be, I'll look to the long-term DeMark charts to be a guide.

First, let's look at the long-term yearly chart of the S&P 500:


Looking at this chart we can see that a TD Sequential sell signal recorded in 1998. After a TD Sequential signal records, the market is given 12 subsequent bars to react. And indeed, we've had a decent reaction, with next year completing the 12-bar window. Meanwhile, a setup in the opposite direction has begun to count, but it's very early in the setup, too early in fact to say if it will continue.

Given that we're exiting the 12-bar window next year, the door is open for lower time frames to become more dominant in their counts, which is why the quarterly charts in my mind are so important. A potential TD Buy Setup on the quarterly charts, combined with exiting the 12-bar window on the yearly charts, would tell me that bears have possibly wrung as much long-term risk out of the market as one could hope.

Notice, I said "long-term" risk. Short-term risk is, for most people, leveraged risk. Long-term risk is different. Since 1997, the best buying points have all come below 900 on the S&P 500. Yet, we're all programmed to believe that moves below 900 could quickly usher in something far worse... perhaps 450? More than a few economists and market thinkers I have great respect for believe 450 could be a reasonable downside target.

Moving on to the quarterly chart, let's look at where we stand as the fourth quarter comes to a close.

Below is the quarterly chart of the S&P 500 as of the close of the third quarter.


I marked the prior TD setups. A buy setup in 2002 was an important turn, while the muted response to the sell setup in 2005 was an important warning (because setups typically produce a reaction in one to four bars) that upside momentum was strong enough to blow through it and continue the trend.

As well, note that the move above the dashed green line was a disqualified break in 2007 and that, so far, the move below the red TDST downside line is disqualified. A qualification of these lines is important because a setup that breaks a TDST line in a qualified manner is a warning that the setup will likely proceed to a full TD Sequential countdown. The fact that the TDST was not qualified in the downside break in late 2008 and early this year is at least one feather in the bulls' cap.

So, given that picture as we entered the final three months of this year, what four scenarios were we looking at?

Scenario 1

Q4 2009 = close below 960.84, but above 903.25, so buy setup is interrupted but TDST potentially qualified.

Q1 2010 = no lower open, no lower low, so no qualification of TDST Down level, which means lows have been seen.

Looks very doubtful we'll close below 960.84. So in all likelihood this most bullish scenario has been ruled out.

Scenario 2

Q4 = close above 960.84, buy setup interrupted, likely that the ultimate low could be in and 960.84 is support.

So far, this scenario appears to be playing out, but I wasn't as clear as I should have been on the importance of not qualifying a break of 960.84. More on this in a moment.

Scenario 3

Q4 = close below 903.25, buy setup continues.

Q1 2010 = buy setup perfected.

Scenario 3, as long as the TDST Down level is NOT qualified, would be bullish. But that scenario is very likely out the door.

Scenario 4

Q4 2009 = close below 960.84 but above 903.25 so buy setup interrupted.

Q1 2010 = qualification of TDST level, which would imply a full countdown.

This scenario too has all but been ruled out barring a collapse in the final four trading days of the year.

Okay, so let's go back to the quarterly chart and see where we currently stand.


As you can see, it appears we will interrupt the potential buy setup, close higher than the third quarter and, based on the qualifiers I use, close above the disqualified TDST Down level. Last week on the Buzz and Banter I noted the importance of this quarter's close compared to last. Let me explain that further.

In order to qualify a break of the TDST Down level, we must first have an up close, followed by a down close below the TDST Down level. Since the first quarter of 2009, we've had three consecutive up closes. In order to potentially qualify a break of the TDST level, we would then have to close below 960.84 in the first quarter of 2010 -- we would then need to meet the open restriction in the following quarter. So 960.84 is the level for bulls to watch.

Okay, so let's put some additional pieces together by going to the smaller time frames.

On the monthly chart, December will record bar 8 of a now perfected potential sell setup below the TDST up level. In order to achieve a sell setup, January must close above the close four bars earlier, 1057.08. With a sell setup very likely to record in January, it will be important for the resulting selloff to be contained by 960.84.


The weekly chart is also helpful in determining our more immediate context. The qualified break of the TDST Up level in July told us to expect a full TD Sequential countdown. That TD Sequential 13 countdown recorded in late October but produced only a short response. An overlapping TD Sequential sell signal is now on bar 7, as is a potential sell setup. Again, given the monthly chart, we should anticipate a selloff in late January that bulls will want to see ultimately contained by 960.84.

There are obviously many ways to deal with 960.84 as an important level of containment. On the upside, using TD Absolute Retracement Up from the March lows low bar's close, 1105.71 has not yet been qualified as an upside break. A qualification of that level would add further confidence that bears will remain on the defensive. Using the low bar's low, the TD Absolute Retracement Up level was already qualified at 1078.87.

A brief rundown of other major indexes, the quarterly charts are all fairly similar. But the monthly charts are very interesting.

The Nasdaq Composite has perfected a TD sell setup this month. The Nasdaq 100 perfected a sell setup in November. We should expect those indexed to lead on the downside in the first quarter.

Finally, take a look at small-cap stocks. On the daily chart, a TD sell setup has recorded as of today, Christmas Eve, on the Russell 2000, but after a 1-4 bar pullback there's the possibility of a qualified break of an upside TDST level at 623.24. On the weekly, we have no signs of exhaustion and haven't completed a TD Sequential sell signal since a qualified upside TDST level break in May. The monthly is on bar 8 of a potential sell setup that, like the S&P 500, could record in January. Still, the context there isn't as bearish as other indexes.

Food for thought. Happy new year.
No positions in stocks mentioned.

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