In April 2009, with the Dow at 8000, I wrote the following four- part series on the making of a bull market:
Now that the market has risen significantly since this series was published, today let’s look at what the next stage of this bull market could potentially bring.
If this is like other bull markets, then the next phase could last from 1-2 years (the total phase of many bull markets runs 3-5 years). During this second phase, you’ll likely see the following:
1. Earnings will improve and often beat expectations. Why? The first reason is soft comparisons. Looking back a year ago the economy was at a bottom, and corporate sales and earnings reflected this. Though the press likes to portray corporations as static lumps of coal, in reality they are dynamic organizations, run by smart and seasoned business people. These companies know how to slash costs (often to an extreme, hence the high unemployment rates today). Therefore additional revenues flow to the bottom line leading to a rising earnings scenario. This then leads analysts (fundamental analysis is a lagging indicator…that’s why the analysts missed the recession of 2000-2002 and the debacle of 2008) to begin upgrading their forecasts. These upgrades attract momentum buyers (money managers who buy rising earnings) therefore leading stock prices higher.
2. Denial is still in affect (see my analysis done last year). Why? Because these money managers and analysts who have been so bearish (and also dead wrong) are way too committed to this bearish scenario. They jump on any piece of negative information to affirm their case. But as in every bull market (and again in this one), they are mistaken. Some go away quietly (think Nassim Taleb) and others continue their cause in public (think Roubini and Grant). These people are smart and mean well. They were right when the market dropped, but very wrong when the market rose. They have agendas – and always beware of analysts who have one-sided agendas. The reality is many of these naysayers sometimes never go away.
3. The last hour bursts, as I mentioned last year, will continue. Quiet/down all day with breakouts in the last hour (and yes you can create quantified trading strategies around this).
4. The pullbacks are often small like we’ve seen this year, interspersed with deep pullbacks as we saw in January.
5. Volatility from this point on will even out. It’s dried up today and the VIX is trading under its average level of the past two decades. It will oscillate from here but not see the bear market increases until after the market breaks under the 200-day moving average again.
6. This market reminds me a bit of the 1990’s, the Republicans have a tough time understanding the economic policy being created in Washington (and I’m one of them). Many who will not go long stocks and have missed the upward move. But they also likely caught the move in gold. Interesting scenario and this is the part that’s new to this bull market. Every bull market brings with it something new and whether the gold bugs and long stock buyers can both be right remains to be seen. But so far, both have been rewarded.
7. During this stage, IPOs will increase. The biggest and best will go to market first. And often some of the newer better technology companies will be among the biggest winning stocks over the next two years.
8. Interest rates will likely rise. Every time the Fed makes a move in this direction, the market will likely pullback (sometimes sharply), and then shrug it off and move higher. It takes a while for monetary policy to stop bull markets.
9. The current move will likely continue until everyone buys into it. When that stage occurs the bull market will enter its third and final stage. But today, that’s still a long way off.
I’m quantitative in nature. Ideally we want our strategies quantified before trading them. I feel everyone should be doing the same. And a major advantage of quantifying behavior is that it allows you to overcome much of the negativity that often accompanies the first few years of a new bull market.
Yes, the fiscal policy currently in place is not good. Everyone who makes six figures or more per year is already beginning to see this in their tax bills. And it will get worse before it gets better. That’s the bad news.
The good news is that the market broke above its 200-day moving average last year and has continued rising. The fundamental analysts had it wrong (as they often do). Those who rely upon quantitative analysis have it right. The market behaves in a fairly predictable manner when it gets above the 200-day. The economics may not be right. But those of you who use price as an indicator (and price is at the heart of quantitative analysis) have avoided much of the pain the deniers have had to endure. And you’ve been able to choose your spots to enter into long positions, often capturing gains along the way.
And the best news of all is that if this bull market is like many others have been, you’ll have another 2-4 years to continue to do this.
Larry Connors’ Daily Battle Plan Model Portfolio has had 51 winning trades and 11 losing trades since October 2008. If you would like a free trial to his daily service, please click here.
Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.