Both declines saw an initial leg down followed by the mother of all counter trend rallies. The 1929/30 counter trend rally lasted a little more than five months and retraced 62% of the previous decline. The 2009-11 counter trend rally retraced 86% of the previous decline (based on the Dow).
Here are some newspaper headlines that appeared in April 1930 towards the end of the biggest sucker rally, so far:
- “The outlook is favorable” — Harvard Economic Society
- “The depression is over” — Herbert Hoover
- “There is nothing in the situation to be disturbed about” — Andrew Mellon, Treasury Secretary
- “Wall Street was in a cheerful frame of mind as a result of numerous vague reports of improvements in business and industry” — Wall Street Journal
Following this brief flash of confidence, the Dow tumbled 10% within two and a half months. Interestingly, this second major leg of the bear market kicked off in April.
Fast-forward 81 years to April 2011 and we read the following headlines:
- “Global economy is improving” — GE (NYSE:GE) CEO Immelt
- “Sales growth the biggest surprise on Wall Street” — Wall Street Journal
- “Equities finally seeing light on the economy” — MarketWatch
Just when Wall Street thought the bear market was over, the S&P delivered a six month, 20% drop. The Dow, NASDAQ and Russell 2000 followed suit.
The chart below compares the Dow’s performance of 1928 to 1932 to that of 2007 to 2011. It took a break below trend lines in 1929 and 1930 to kick off powerful declines.
It also took a break below trend lines in 2008 and 2011 to unleash massive bearish forces. The Jul. 28 ETF Profit Strategy update pointed out that the corresponding trend line for the S&P is at 1,298 and stated that: “A break below the trend line may trigger panic selling”.
The S&P dropped below this target on the following day and lost over 20% in the next seven trading days. Since this trend line has been rising pretty rapidly, it is unlikely that the S&P will visit this trend line before the next leg down.
However, there’s another trend line (not shown in the above chart) that’s crucial for the short-term fate of stocks. This very trend line is now the ideal target for this rally. This is apparent because this trend line corresponds exactly to the trend line created by the 2007/08 market top.
In fact, the parallels between today and 2008 are so pronounced that the Aug. 7 ETF Profit Strategy update dubbed it “the script”. Based on the script, the Aug. 7 update predicted that:
- There will be a new low (occurred at 1,075 on October 5) and
- There will be a powerful counter trend rally to around 1,250
This article is brought to you by ETFguide.com. ETFguide is the information leader on exchange-traded funds because of its vendor-neutral approach and its progressive reporting style. Unique features include an ETF bookstore, a monthly e-mail newsletter, and subscription based ETF portfolios.