Will We Retest the Lows?

Anyone still clinging to the idea that the current romp by the bulls is “just a bounce” in a bear market might be guilty of being a little stubborn. As we’ve been detailing weekly for the past two months, we’ve got loads of evidence to back up our opinion that a new bull has been born and that one needs to play the game accordingly.

With that said however, anyone who has ever glanced at an oscillator knows that the market has reached an overbought condition of epic proportions. As such, the glass-is-half-empty crowd has been talking about the need for stocks to not only pull back but retest the March lows – and soon. And those clinging to their bear costumes are likely using this assumption as a reason not to be overly optimistic about the future.

Never mind the fact that the S&P is up nearly +40% from the lows (+37.35% to be exact). Never mind that nationalization of the banks is now off the table. And never mind that the economic data as well as the earnings season in general have actually been better than expected. The bears argue that a retest is an absolute requirement – so we’d best “watch out.”

While we will readily admit that stocks DO tend to retest the lows when coming out of a bear market, this week, with the help of eSignal and a terribly sophisticated program I recently found called Paint, we will draw a couple of pictures this week in order to argue: “Retest? We don’t need no stinking retest!”

Exhibit A: The Bear Case

Before we proceed, we should point out that the market can and often does do whatever it wants, with the end result usually aimed at confounding as many people as possible. Next, we should point out that technical analysis is really more art than science and that there are usually about six ways to look at the same thing (which is why we don’t depend on anything terribly complicated in our work other than trendlines, moving averages, volume, and support/resistance). Finally, we will also admit that we are not card carrying chart techies and that most of our work is probably covered in the first couple of chapters in “Technical Analysis for Dummies.”

So with the appropriate caveats (which are intended to lessen the amount of hate email we will receive from readers who may disagree with our view of the charts) provided, we will offer up the following as an argument that we may not see the stock market retest the March lows in the near future without some sort of new negative catalyst.

The first chart we’d like to present is of the S&P 500 over the past 10 months or so. If you can ignore our handiwork on the right side of the chart, at first glance, it is fairly obvious that March 9th is the low point of the bear market.

   Exhibit A: The S&P 500 and the Bear Case for a Retest

Okay, now you can turn your attention to the terribly creative bit of artwork we’ve added to the right side of the chart – I.E. the arrow pointing down. In short, if the bears get their way, THIS is what they expect to happen and THIS is what the "retest" would look like.

The big decline, which, if our furry friends have a say, would commence immediately. In theory, the decline would be based on the idea that the economy isn’t really all that great right now and the ensuing selling would set up a classic “double bottom” (or even the rare head-and-shoulders bottom). And for some reason, it seems as if this would satisfy many in the bear camp. So, if we’re reading the tea leaves right, after the retest, double bottom, and/or head and shoulders bottom, even the bears are okay with a new bull beginning.

Exhibit B: The “Yea, But” Case

Now let’s turn our attention to the bull camp for a rebuttal. Please keep in mind that we are ignoring any and all fundamental analysis and/or the potential reasons behind any of the chart prognostications. As I told a colleague on Friday, building a case with charts is a ridiculous game to play because I can find charts to back ANY and ALL arguments you’d like to make.

So without further ado, let’s look at a different chart along with the glass-is-half-full gang’s perspective.

   Exhibit B: The NASDAQ's Double Bottom

We’re fairly confident that if you showed this chart to 10 technicians, you would likely hear the words “double bottom” mentioned more often than not. The NAZ hit a bottom in November then rallied up 25% into the January high – which, as it just so happens, is a level that many “bear market rallies” tend to achieve before failing.

Speaking of failing, that’s exactly what came next as the stocks of four-letterland gave back all of the November-December rally and then some into the March 9th low. But as you can see, this low really didn’t exceed the November low by much, which is classic “double bottom” action.

Then once the big banks announced, “You know guys, we’re actually making some money right now” the game changed and stocks took off to the upside on strong volume (always a good thing during an advance from a techie standpoint).

Exhibit C: What’s the Upside?

Next, we’d like to direct your attention to the horizontal line we have not-so artfully drawn in at about NASDAQ 1650. This is intended to represent the breakout zone for the double bottom formation.

   Exhibit C: The Techies Upside Projection

Once an index moves through this neckline or breakout zone, the technical analysis textbooks suggest that the move higher will be, at a minimum, the distance from the bottom of the formation to the neckline. In this case, the neckline is at roughly 1650 and the low was in the vicinity of 1300. Therefore, the upside projection would be 350 points.

If we add our 350 point upside projection on to the neckline at 1650, we get a target of 2000 on the NASDAQ – or another +15% from here. And remember, this is the minimum projection - often times moves of this nature see upside that is two or three times the formation's span.

Back to Reality

So, what should we take away from this little exercise? In short, we are of the mind that we are unlikely to see a true retest of the lows on the S&P 500 during this cycle. Sure, we could and should get some sort of a pullback in response to the overbought condition. But remember, history shows that such pullbacks in markets like this one tend to be contained to -5% or so. If this scenario would play out we would see the bears take the Dow back to 8150ish. Although, to be honest, a move