The Making of a New Bull Market, Part 4

On Friday, Tuesday and Wednesday, we looked at what the past 7 bull markets since 1982 have looked liked as they were coming out of their bear markets.

There are 8 common themes of most new bull markets and they are:

1. There is no rational economic reason for the early rally.

2. The semi’s lead first.

3. Every bear to bull transition is accompanied by the financials. If the financials don’t rally, there is no bull market.

4. Basic materials usually lead too. If they’re not building, there is no recovery.

5. The market pounces on any good news and shrugs off (ignores) bad news.

6. The market will open weak and then close higher for the day and do this over and over again.

7. The last hour of trading is often accompanied by strong buying. This buying is usually caused by large money on the sidelines combined with panic short covering.

8. The US market leads the other world markets higher. It always has and until proven otherwise, it will again this time.

Today, let’s look at numbers 7 and 8 along with adding number 9, which I consider to be the most important rule to follow.

7. The last hour of trading is often accompanied by strong buying. This buying is usually caused by large money on the sidelines combined with panic short covering.

In bear markets the last hour can be brutal. Think about the many days in October 2008 and again in February and very early March 2009, Much of the daily declines occurred in the last hour and especially in the last half hour. When markets are transitioning to bull markets, just the opposite is true. The last hour is often moving higher and often it’s very strong. As I’ve mentioned, this buying comes from panic short covering and also from money managers who need to put money to work (they’ve been in cash, a safe haven for them, and now they run the risk of underperforming unless they get that cash invested). You can really get a good idea of longer term sentiment from that last hour because it’s fairly consistent. In bear markets, it’s often down sharply. In markets that are transitioning to a bull market, it’s often significantly stronger.

8. The U.S. market leads the other world markets higher. It always has and until proven otherwise, it will again this time.

In the late 80’s and early 90’s Japan was supposedly going to conquer the world. They were buying up everything they could and there was a fear that much of the United States was going to be owned by them. Over the past few years this type of psychology was again seen when discussing the major oil countries, and the BRICs, especially China. In fact, one of the big early overnight market declines in 2007 occurred because China had a large one-day drop. Yes, many countries are all tied together more closely than ever before. But, as we saw again over the past 18 months, the US still leads the worlds markets both up and down. This may change someday and the arguments for China are compelling (as compelling as they were for Japan two decades ago), but as we look at the state of the world markets and the world economy today, as the US goes, so goes most of the rest of the world.

As the world markets transition to bull markets, the US will lead the charge, just as it’s done from early March through early April. The US is up 20% from its bottom and most of the other major indices are up because the US has led the way. This has been the story for decades and until proven otherwise, it will be the story for this market too.

9. The single best simple rule to truly guide you through bull and bear markets.

In 2003, we wrote a report which quantified how the market and stocks perform better when they are above the 200-day moving average than when they are below. This study was further updated in my book (co-authored with Cesar Alvarez), Short Term Trading Strategies That Work. When this research was originally published 5 years ago, we quantified the behavior above and below the 200-day moving average and showed statistically, using a sample size of over 8 million trades, that it was better to be buying stocks with the market above the 200-day than below. Little did we realize then that this one rule would be the single best determinant for the future direction of stocks as the bear market starting hitting in early 2008. Many banks and brokerage stocks started breaking under their 200-day moving average in 2007 (an early warning, remember the financials lead) and eventually many dropped 70% or more in value, with some losing almost 100%. This one rule alone could have saved money managers and investors many billions of dollars of losses had they simply avoided the “cheap stocks” under the 200-day average.

This year, as you have seen in the Daily Battle Plan, simply focusing on ETFs that are overbought below their 200-day on the short side has allowed the Model Portfolio to be successful with the 12 of the 13 ETF signals which have triggered. The reason for this is that the market, in spite of the many signs that it is transitioning to a bull market, is still in a bear market. And I’ll define it as a bear market until it gets above the 200-day moving average (and many markets are getting closer).

I realize that eventually the market will race to the 200-day as it transitions and we’ll be short. But using this approach, we’ll gladly give a small piece of the gains back because of the accumulated short side profits that have occurred for those shorting under the 200-day since early 2008. Plus, I know many people who used the 200-day simply to go into cash. And when most money managers are down 35-40% in the past 15 months, it will likely take years for them to make these losses back. Those who used the 200-day and went into cash, have most of their original money in still place (and some are even up for the past two years) and they can continue to grow their money from here.

The 200-day rule is a good rule and one that has been good to many people for a number of years.

This wraps up my series on how to identify when a bear market is transitioning to a bull market. I don’t have the crystal ball to know when the next bull market is. But market behavior often repeats itself and the 9 rules above have repeated themselves for 7 consecutive bear markets since 1981. It’s a good track record and a track record that’s worth following for years to come.

I hope you enjoyed this series.

To read the first three parts of Larry Connors’ series, “The Making of a New Bull Market,” click here for Part 1, click here for Part 2, and click here for Part 3.

This is from Larry Connors’ Daily Battle Plan which he publishes each morning. If you’d like to take a free trial click here, or call 1-888-484-8220 ext 1 to start your free trial today.

Larry Connors is CEO and Founder of and Connors Research.