Most financial commentators are excited about yesterday’s sizable rally in the equity markets, thinking it a sign that the Bull has returned. Of course, since most financial commentators are credulous fools with no sense of history, they are completely wrong.
It may be counterintuitive, but sharp, powerful rallies are actually a very bad sign for the stock market. Consider that since May 1, 2002, there have been 30 days wherein the Dow closed at a 2 percent gain or more, including yesterday. 12 of those big rally days occurred in the 113 trading days from May 1 to October 10, 2002, when the Dow went from 10,059.63 to 7,181.87, losing almost a third of its value, a big rally ratio of 10.62 percent.
Of the other 18 that occurred in almost three years of post-October recovery, five occurred within the first eight days of the intermediate-term October 10 low, with six more in the next three months. These 18 big rally days have been amassed in 637 trading days, for a big rally ratio of 2.83 percent.
Furthermore, the average big rally when the trend is down is 3.6 percent, whereas the up-trand big rally averages only 2.29 percent if one excludes the first two days of the rebound. Therefore, unless yesterday’s performance is followed and surpassed by larger rallies over the next week, one must conclude that yesterday’s big day is a powerful confirmation that the bear market has resumed and it is time to exit your long positions.
In summary, big rally days cannot be considered indicative of bull markets or intermediate-term recoveries, except at the immediate beginning when they occur in rapid progression.