Last week’s powerful one day rally had the bulls pounding their chests and the bears eating crow. But the technical damage of the past three weeks has been too significant to ignore. The internals of the rally day were powerful, with A/D and up/down volume excellent. But Nasdaq’s volume was only modest, suggesting institutions have yet to step in. They are what drive rallies further and broader. It’s just as foolhardy to ignore a 200-point day as it is to close your eyes and blindly plunge in.
Measured market gains are more preferable than spasmodic leaps upward. It simply is healthier to see rational moves higher – i.e., five 40-point days over a few weeks – than a single 200-pointer. These emotional buying frenzies have a whiff of panic to them. That tends to have unfortunate consequences down the road for buyers and sellers. Further, a market rally does not make all the prior economic concerns of disappear. Oil prices, deficits, inflation, slowing GDP, waning earnings momentum and current account deficits do not just go away because a day of “animal spirits” turned the recent red screens green for a day.
All that said, it would be plain ol’ dumb to ignore the potential significance of a big up day, especially coming after three weeks of selling. Prior to the move up, many oversold and sentiment indicators had gone into alert mode. Given that sharpest rallies occur in Bear markets, the question of primary concern is now this: Was this merely a vicious bounce within a longer downtrend, or was this the start of something new and wonderful?
We have come to rely on William O’Neil’s methodology as a way to participate in market turns without putting too much at risk – including missing more upside or risking more downside. Separating the "one-day wonders" from the important turning points requires finding evidence that institutions had regained their appetites for equities: A significant follow-through rally four to nine days after the first big move up after a longer downturn. Requirements include the major indices rallying 1% to 2%, and on greater-than-average volume, in that five-day window. This window opens Tuesday, April 25 and runs for 5 market days. This method has a rather respectable track record.
My concerns about the market here have to do with the fallout from the post-election trading ranges. All the major indices broke out into newer higher ranges in November 2004. The Dow made a four-year high in January, then the indices dropped back into their prior pre-election trading ranges. While a return to these levels would be very bullish, we are wary of potential failure at the levels just below: Watch SPX 1165, Dow 10,400 and Nasdaq 1991.