2010 The Year Ahead - Part II

In many respects the rally of 2009 mirrored the decline of 2008 just as the dramatic decline of 2000 to 2002 in the Nasdaq mirrored the parabolic rise between 1997 and 2000 and the recent dramatic fall in the price of oil mirrored its extraordinary rise. This is a common occurence in markets. When extreme moves are seen in one direction, there is often an extreme move in the opposite direction. But for the stock markets, most of the momentum of the rally in reaction to the 2008 selloff is probably over. So, we are left with the question of what to expect in 2010.

There are extreme views and there is the consensus view. To date I have only seen one analyst who is presenting the interpretation that we are in a new secular bull market. This analyst expects new all time highs for the stock markets in the not too distant future. Mostly, it seems that the extremists are in the bear camp as many, particularly those in the elliot wave group, believe that the worst decline in the last 100 years is near at hand. The most dire predictions are that the Dow will fall below 1000 and perhaps even as low as 400. Personally, I don't put much stock in either of these extreme views. The consensus view is that markets will continue to rise into the end of 2010, but with only modest gains. The consensus view is not likely correct either.

We can probably rule out the secular bull market case quite easily by looking across market sectors. If I were expecting a secular bull market, I would expect to see greater synchronicity in the pattern and momentum across many market sectors. We just do not see this. While a few sectors are showing possible 5 wave advances from the market low, the pattern of the rise for most sectors from the March 09 low appears to be choppy with overlapping waves and lots of triangles. In a secular bull market I would expect to see clearer and more distinctly impulsive advances. The second reason that this is probably not a secular bull market is simply that the bear market has not been long enough. If we count the secular bear market from the 2000 top, then we only have 9 years. The typical secular bear market has been 12 to 16 years.

On the other hand, we can probably rule out an imminent primary wave 2 top by looking at some individual stocks. While Robert Prechter is fond of saying that the indexes don't have to behave coincidently with the underlying stocks, I have just not found that to be true. I distinctly recall posting a question at EWI back in 2003 asking how the bear market could resume so soon with so many stocks rising impulsively. I did not get a satisfactory answer, and as you know the rally continued for some time thereafter. The fact is that with stocks like AXP, HPQ, IBM and UTX rising impulsively during this rally, we should not expect that the Dow is going to fall to new bear market lows near term. I can also list a great many other stocks sporting 5 wave advances. These stocks point to a near term correction developing with at least one more leg to complete the bear market rally.

Looking back to 2003 and 2004, the rally off of the March 2003 low topped on January 20, 2004 in the Qs and on February 19, 2004 for the Dow. While such comparisons rarely hold up, the rallies are similar. After the top in early 2004, markets pulled back to the 200dema and then traded sideways for the rest of the year.

Without getting into the details, the main difference between 2010 and 2004 is the phasing of the longer term cycles. We are now very definitely on the downside of the 10 year cycle which last bottomed on October 11, 2002. This will begin to weigh on the markets just as the currently contracted 4 year cycle is running out of steam this summer.

Putting the big picture observations together, we should expect some sort of correction in the first quarter of 2010. Once that correction is completed, we should expect another rally leg of equal measure in points to the first rally leg, but with a divergence in breadth and momentum. When the second leg is finished, the secular bear market will return.

In Part III, we will look at the possible form of the remainder of this bear market.