The Market’s recent action has been very reminiscent of the pre-war activity in the first quarter of 2003. After making a capitulation low in October 2002, the market came in for a retest on lighter volume – right up to the War’s beginning.
October 2002’s sell-off was characterized by heavy distribution – the dumping of stock was rampant. That marked the bear markets low’s. Leading up to the March 2003 retest, the market exhibited a very different character. Those queasy few months were more of a buyer’s strike than a selling crescendo. Nerves were frayed, duct tape alerts abounded. With investors distracted by the upcoming war and other geopolitical events, volume was actually rather anemic.
Thinking about trading as we are sending troops into harm’s way was very much besides the point.
2004 is in many ways parallel to that same process. After peaking on January 26, the markets made a new low two months later on March 23. The indices got way ahead of themselves, as the the Dow gained over 500 points in 8 days, while the Nasdaq tacked on a cool 10% run up.
Of the 900 points the Dow has given up from it’s April highs, the majority of has come about since the Iraqi prison photos were released 2 weeks ago. With over 60% of Americans believing the situation in Iraq is “out of control” (WSJ), geopolitical factors have — just like last year — weighed on sentiment, negatively impacting equity markets.
Hence, a low volume retest makes osme sense, as buyers get distracted by other, rather weightier matters.
All this has built up to Wednesday’s key reversal day: May 12, 2004 saw the market plunge and make up all of its lost ground. After dropping nearly 170 points, the Dow closed positive – a 200 point swing. The Nasdaq likewise made up nearly all of its losses to close at the day’s high. This Hammer bottom has been a reliable signal for future gains.
Additionally, the market was about 10 to 1 negative – at least intra-day – on both the NYSE and the NASDAQ. In the past, that has been another good signal of impending reversal. And as the nearby chart shows, net 52-week highs are below the zero line, and have reached similar readings as March ‘03. This is also suggesting an oversold condition.
Since the Semiconductors (SMH) had led the Nasdaq down, watch that sector to exert leadership in any subsequent rally. Being short at this juncture is especially dangerous, in our opinion. While there may be opportunities in the future to trade from that side, we expect them to come from significantly higher levels.