Opinion: This stock market rally has more upside, but expect any relief to be brief

The U.S. stock market’s impressive rally last week is more likely a reflex bounce than the beginning of a new leg of the bull market. I say that not because the rally ran out of steam on Monday, with the Dow Jones Industrial Average
DJIA,
+0.74%

falling 202 points, or 0.6%, and the Nasdaq Composite
COMP,
+1.95%

falling 0.4%. This conclusion was already clear over the weekend, based on my review of a number of indicators and interviews with several market historians.

One worrisome straw in the wind is the eagerness of so many on Wall Street to declare that the worst is now behind us. That’s just the opposite of what is seen at major bottoms, when the consensus belief is that the initial rally off that bottom is nothing more than a bear trap.

A good illustration of this enthusiasm is how Wall Street analysts are focused on the stock market’s positive “breadth” — the difference between the number of stocks rising versus those declining. According to some of these eager beavers, last week’s breadth readings were so positive as to constitute what some technicians refer to as a “breadth thrust buy signal.”

Yet these bulls may have jumped the gun, and here’s why:

Developed in the 1970s and 1980s by the late Martin Zweig, an advisory newsletter editor and famous Wall Street money manager, the Breadth Thrust Indicator is based on the 10-day moving average of the stocks rising in price as a percentage of those that either rose or fell. In Zweig’s formulation, this indicator generates a buy signal when this moving average rises from below 40% to above 61.5% within a 10-day period.

Though some claim that these preconditions were met last week, others differ. Hayes Martin is one of them. In an interview, he said that the moving average last week never quite reached 61.5% and has since turned down. Close but no cigar, in other words. Overall, he said, last week’s breadth readings were good but “not really good.”

Martin is president of the advisory firm Market Extremes. Several times over the years I have reported on Martin’s predictions of market turning points, which overall have been impressive. (For the record: Martin does not have an investment newsletter; my newsletter-tracking firm does not audit his investment performance.) The last time I wrote about Martin was last July, when he projected a 10% correction. Though he was somewhat early, the S&P 500
SPX,
+1.13%

fell 5.2% from its early September high to early October low, and the Nasdaq fell 8.3%.

Another reason to question last week’s breadth readings, Martin added, is that he’s found from his research that breadth is better measured by comparing rising and falling stocks’ volumes. When measured in this way, the market’s breadth — while still positive — has been even less bullish than the price-only version, falling “well short of a genuine thrust extreme.”

In any case, Martin argued, we should never base a market forecast on just one indicator. Some of his other indicators with solid track records are telling a less-bullish story than the breadth data. Taking all of his indicators into account, Martin said that while there is the “potential for a very strong countertrend rally,” the conditions are not yet in place for a final bottom to the market’s recent weakness. On the contrary, he says there is a “fairly highly likelihood of one and maybe two retests of the market’s recent low before a new bull-market leg will be launched.”

One of the reasons Martin is forecasting these retests is that market sentiment in recent weeks never reached the extreme levels of stubbornly held pessimism that are typically seen at a market bottom. He said that while some individual sentiment measures have reached such extremes, others have not. Even those that did reach extremes didn’t remain there for long. The “totality of pessimism extremes has just not been seen,” Martin added.

How strong of a countertrend rally is Martin projecting? He estimates 10% to 15%. Since at last Friday’s close the S&P 500 was already 7% higher than its correction low, that means the upside potential in his opinion is in the range of another 3% to 8%.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]

More: As stocks wobble, the March 2000 Nasdaq top is a harsh reminder that the long run isn’t always your friend

Also read: These 10 dividend-paying stocks show why cash isn’t trash in this brutal market

Source: https://www.marketwatch.com/story/this-stock-market-rally-has-more-upside-but-expect-any-relief-to-be-brief-11647932476?siteid=yhoof2&yptr=yahoo