Substantial
Profits Lie Ahead
by Jeffrey Hirsch, editor
Stock Trader's Almanac Investor
The
long awaited Midterm Bottom has likely been reached. The Midterm
Rally is underway and we anticipate a 50% rise from the October
9 lows to Dow 10929, S&P 1165 and Nasdaq 1671.
For the last five months
we have been expecting a behind-the-scenes bottom in the early
fall ahead of the Best Six Months, November to April. We anticipated
that it would coincide with the most powerful historical pattern
of all, the 4-Year Presidential Election/Stock Market Cycle (the
last two years, pre-election year and election year, of the 42
administrations since 1832 produced a total net market gain of
722.4%, dwarfing the 251.7% gain of the first two years of these
administrations). Astute Almanac readers know that most wars,
recessions and bear markets occur in the first two years of a
President's term. Ring a bell? We certainly have had all three
this time around. The latter two years are usually marked by
prosperous times and bull markets. The third year of the cycle,
the "Pre-Election" year is the strongest.
Major bottoms often
occur in the second year, the "Midterm" year, as in
1934, 1938, 1942, 1962, 1966, 1970, 1974, 1978, 1982, 1990 and
1998. These were all important bear market bottoms. 2002 appears
to be falling into the same category. Most impressive is the
average 50.2% gain on the Dow from the low in the Midterm year
to the high in the following Pre-Election year.
Presidents tend to
push through the least favorable aspects of their agenda in the
first half of their term and focus on creating a prosperous electorate
in second half with wealth producing programs and initiatives
so voters are happiest at election time.
Back on May 15 in our
June issue we warned not to get caught in the bear market rally
and to look for volume to dry up during the summer creating a
"natural bottom" in the fall when Wall Street resurrects
stocks out of nowhere. J. Taylor Brown detailed "How to
Spot a Bottom" in the Proving Grounds that issue. His prescient
analysis, "Anatomy of a Bottom" came months ahead of
the Street jumping on the low-volume-bottom bandwagon.
Recently Investor's
business Daily opined, "It was just the sort of undercover
climax that might actually stick." We think it will. Mr.
Brown warned that this sort of bottom would be difficult to spot,
as it is not accompanied by an obvious event that ends in a major,
often one-day, capitulation of stock prices on extremely heavy
volume.
In the natural bottom
cases sited, volume is muted near the end but is followed by
heavy trading in an up market. Exactly what we have just experienced.
The larger 6.1% drop in the five days preceding the October 9
bottom is reminiscent of the 6.6% loss just prior to the December
6, 1974 natural bottom. Going back further is the natural bottom
of 1932, the low point for the last century.
The Dow rallied 93.9%
then in two months. Sure the market sold off after that with
the Dow dropping 37.2% by February 1933. But, the market never
looked back after that, rebounding to close out 1933 at better
than double the July 1932 low. It was the beginning of the end
of the Great Depression and stocks enjoyed 4 consecutive years
of solid gains.
The action on October 15 is a clear follow through and solidifies that a major rally is underway. Stocks posted near record gains on increased volume that was well above average. The pullback on October 16 was constructive profit taking on light volume. Mutual funds and institutions don't seem to be selling this rally.
This is different than July. Preceding this bottom, selling pressure on stocks has been exhausted as we experience the highest degree of pessimism we've seen since just after 9/11 just what you expect at major bottom. Bears outnumber bulls by a healthy margin. Investors Intelligence Investment Advisors Bearish Percent is 43.2% versus 28.4% for the bulls.
The 28.4 percent bullish number is well into bullish territory. Add in the 28.4% of investment advisors on the sideline and we have over 70% of advisors thinking the market is going down or nowhere and less than a third who think stocks are set to rally. Just what this contrarian ordered. Count us firmly in the bullish minority.
The glut of bad news in recent months corporate scandals, economic struggles, high consumer and corporate debt and war fears has run out. The market has discounted all of this already. With the worst behind us, as is historically the case, stock prices have begun to turn up 6 12 months before the economy turns up.
Recent good news about earnings, albeit from lower guidance and 3 years of drops, a slowing of the economic bleeding in numbers that have not appeared to worsen, gives the market reason to expect a more healthy recovery in the next 6 12 months. Markets tend to turn 6 12 prior to economy. Uncertainty over war has been discounted and Congress' getting behind the President helps to alleviate fears of a country divided over the decision to go to war. As in 1990, stocks bottomed in October as the stage was set for a conflict in Iraq and the first Bush administration prepared the military and the rest of the nations.
Editor's Note: Jeffrey Hirsch is editor of Stock Trader's Almanac Investor, 184 Central Avenue, Old Tappan, NJ 07675, 1 year, 12 issues, $195.
