The Bull’s End Is Near! (OK, It Isn’t)

by James Brumley | May 15, 2012 8:14 am

Ready to throw in the towel with your portfolio? Wave the white flag until further notice? That’s understandable, given Monday’s action from the market.

The sellers — not satisfied enough with the 3.5% selloff doled out over the prior two weeks — were chipping away again. In fact, Monday’s dip could be considered the one that broke the camel’s back. At least at the end of last week the S&P 500 still was finding a technical floor around 1,346. With Monday’s low of 1,336.60, there’s just not a lot left to prop the index up. Point being, it would be easy to jump on the “The End is Near!” bandwagon.

Just be aware that doing so now could be the biggest trading mistake you make all year long.

The fact of the matter is, the pullback since the S&P 500 peaked back on April 2 has only wiped away 6% of the market’s value … not that much. And bluntly, it’s a move we should have seen coming anyway, for a couple of reasons.

More important than any of those details, however, is that this pullback is setting up an incredible buying opportunity for those who can look past the hysteria and keep their composure.

Where We Are

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While the good news is there’s a light at the end of the tunnel, the bad news is we might have to suffer a little more pain before we get back on the road to recovery.

As the nearby chart illustrates, the 100-day moving average line, as well as the lower 50-day Bollinger band (both of which play key support and resistance roles), were staving off the sellers for the bulk of last week. The bears got off to an early start this week, though, knocking over the bulls’ last line of defense. Now that the levee’s broken, the floodwaters are flowing.

It’s not an entirely bad thing. Indeed, the breakdown actually might be performing a valuable service: releasing the bulk of the overbought pressure that had been brewing since mid-December. All told, the market ran up 17% between the end of last year and late March, which, as most trading veterans can tell you, is too much, too fast, to hold onto.

And the market didn’t hold on.

So where does the bleeding stop? It’s not an exact science, but the normal corrective move for stocks during a bull market is usually on the order of 8% to 9%. Assuming this one is as normal as most, that would put the landing spot for the S&P 500 right around 1,300. It’s likely not a coincidence that the 200-day moving average line is waiting to act as a floor right around there.

The Bigger Bullish Case

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Still not convinced there’s ultimately going to be a bullish outcome here? Are you really subscribing to the “This time it’s different” platform?

To each his own, but know that the same argument was being made around this time in 2010, as well as around the middle of the year in 2011. Both of those times, the market just seemed beyond salvaging too, yet within a matter of months, that very same market was hitting new multi-year highs; those times weren’t different after all.

See, we’ve seen this exact same thing before.

The nearby chart says it all. It’s not a matter of valuation or geopolitical problems or a surprise recession digging into stocks. More than anything it’s the calendar, coupled with the fact that the market’s just plain-ol’ overbought.

It’s a pattern we’ve seen in both full years of this bull market so far. Each time April ends and May begins, a red-hot rally (blue) gets stopped cold and a sharp pullback follows. While the 200-day moving average line admittedly might be a questionable landing pad for the current pullback, betting against a well-established, calendar-based pattern isn’t a great idea. It’s just going to take some patience and faith to capitalize on it.

Bottom Line

Bear markets almost always begin with falling earnings and shrinking productivity — two clues we’ve yet to see in 2012. All we’re likely seeing now is a self-fulfilling “Sell in May” prophecy, as we’ve seen the past two years. The media might be losing its mind over the dip, but it actually has been a predictable garden-variety correction so far.

It’s also an opportunity for savvy investors who can look past the hysteria.

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