History Says Pullback From Stock Market Rally a Solid Bet

By Albert Bozzo
|  Tuesday, Apr 21, 2009  |  Updated 2:15 PM EDT
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There's more where that came from.

That's what some market watchers are saying about Monday's sharp selloff, following a stunning—yet, some say, suspect—run-up of well over 20 percent from the standing bear market low of March 9.

"Whenever you get that kind of move in that short a period when news is still mixed, you're vulnerable to a setback," says money manager Jim Awad, managing director at Zephyr Management. "We've gone from the bear market to the never-never land."

Caution and skepticism has been building in some quarters recently, particularly as the Dow Industrials hugged a 200-point trading range over the 11 sessions going into Monday.

To some, however, the writing was already on the wall late last week, even as the major indices edged to new highs Friday in their spring sprint.

"This thing is due," veteran market watcher and UBS floor operations director Art Cashin told CNBC early Friday. "I'm betting we're going to see that pullback in the rally."

Cashin, among other things, cited the narrow nature of the rally and how many of the stocks attracting interest were "low-priced stocks," often a sign of indiscriminate bottom fishing.

Sam Stovall, chief investment strategist at Standard's & Poor, says technical data and historical trends pointed to an April 17 high, followed by the typical retreat and retesting of the bear market low.

In his March research note, Stovall said the S&P 500 could post a rally in which it recovered some 22 percent of what it lost during the bear market in a 39-day period, the historical rule.

"If history repeats itself, we would probably go through a retest," said Stovall. "We're just at the beginning of the retest today."

Over the years, that retest has averaged about 20 days from the recovery high and knocked 7 percent off the market.

This time, Stovall says, the indicators point to "a correction of some magnitude," perhaps along the lines of the 14-percent hits suffered during the 1973-75 and 2001-2002 bear-market periods. The S&P, for instance, could fall back to 750 after traveling from its March 9 low of 660 to just under 870 last Friday.

Others see a more moderate pullback. Hedge fund manager Doug Kass, for instance, recently told clients to expect a decline of 5-6 percent after the recent rally.

"I can understand why people could be concerned about jumping back into this rally," says Stovall. "They were lulled into thinking there was a bottom in March '08."

A quick look at recent history might suggest why this rally may be too good to be true.

In the 2001-2002 period, there were major bear market rallies in a roller coaster pattern. The Dow, for instance, fell from from 9,808 in early May to 7,702 in late July. By late August, it was back up to 9,053 before quickly spiraling down to 7,286 in the second week of October.

That's not all. By late November, the blue-chip index was at the 9,800-level, only to drift back down again to the 7,500-level in March 2002. The bear market technically ended in October of that year and the Dow reclaimed the 10,000-level by mid December.

The timing of this rally also does not bode well for what lies ahead, says Jeffery Hirsch, editor of the Stock Trader's Almanac, who notes the market's traditional bullish period runs from November-April.

"Some of the old seasonality may not be in effect; that in itself is a negative indication," says Hirsch. "We've stalled at that 8000-ish resistance level and we’ve got the bad season coming on."

Hirsch notes that the Dow has had only four up months in the 17 dating back to Nov 2007--right after the record highs of October--and that the market has posted gains on only two Mondays since early December, suggesting investors don't want to jump back in after the weekend when they are traditionally loathe to be long. 

That sort of bearishness does not mix well with seasonal performance, especially when investors remember the two previous major false bottoms of this bear market.

"With people burned as much as they have been, they get out when they can," says Stovall, referring to those who may now be exiting the market after a huge run.

Uncertainty, says analysts, remains the dominant factor, from earnings to the economy to the government rescue package.

"It's unlikely anything in the real world can justify any sustainable move up in stock prices from here," says Awad. "We're likely to go through a period of great confusion, where the bulls and the bears tug it out and the real world is somewhere in between."

Right as earnings season swings into high gear this week, the Treasury will be releasing the first round of highly anticipated information on the bank stress tests this Friday, followed by the second installment May 8.

"This week will tell the story," says Awad. "You have a lot of excuses for the market to correct and go down."

For more stories from CNBC, go to cnbc.com.

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