Clarifying the ‘5% Rule’ and ‘Mirror Image’ Scenario

I received a lot of questions recently about the same issues, mentioned both on the air and in a recent column: Recapping the First Half of the Year.

So many emails make it obvious that I was unclear — Allow me to resolve the confusion:

The first question had to do with what I termed “the 5% rule.” Although I had mentioned it here previously, not everyone (horror!) reads my every last word. I discussed the 5% retracement rule back on March 11.

In brief: Rarely does the first 5% pullback doom a rally to failure. Historically, this initial 5% retracement on the Dow and SPX (but not the higher beta Nasdaq) occurs at — roughly — the 60% mark (i.e., the rally has achieved 60% of its gains and has another 40% to go). Note that this is just an average, and there will be occasions when the first pullback happens either sooner or later than that point. You can read more about it at the link above.

The second issue was what I meant by a “mirror image” of the first half of the year. Since 2004 started strong, peaked late in the first month and then reversed for the next five months, the mirror image would mean starting out soft, bottoming and then rallying for most of the rest of the year.

That’s my expectation for the next six months — we are a little overbought at present, the next major dip (in my opinion) should be a good buying opportunity, and then the presidential election year trends and the big M2 increases should power us higher the rest of the year.

My apologies for the confusion…

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