Don’t Be Fooled by Last Week’s Rally in Stocks

Bear Market Rally

It’s amazing what a week can do to change people’s minds.

Until a week ago, the mood of investors and the financial media was mostly negative. “Fear” and “panic” were the buzzwords.

Then the stock markets rallied strongly in just 3 trading days, and now suddenly everyone is talking of a “return of the bull market” and a “bottom” in stocks.

But not so fast!

As I shall explain to you in this essay, there are strong signs that the panic and weakness in stocks is not yet over… and there is a chance we could see lower levels in the stock market.

The first thing we need to remember is that last week’s rally in the stock markets was NOT random or unexpected.

Our LeadingTrader subscribers are well aware of a repeating pattern in the stock markets: that stocks tend to rally in the week leading up to the THIRD Friday of the month.

We first revealed this pattern last year. It has a 70% win ratio and it worked again this month.

So last week’s rally in stocks was by no means an “accident” – and the fact that so many people were bearish on stocks made it even more likely to happen.

Now take a look at this monthly chart of the S&P 500 index:

S&P 500 monthly chart

We can see that the S&P is currently still below it’s 21 monthly average at 1975 (see the red arrow pointing to the blue line). This is a KEY level in the stock market and it is one of the best ways to identify the barrier between a bull and a bear market.

In the past 50 years going back to the 1970s, whenever the S&P 500 has closed TWICE below it’s 21 monthly average, this has led to either a very strong correction or a bear market.

The last time this signal occurred was in 2008, right before the market crash of that year…

Now, it is important to remember that the February month has not finished yet. So that 1975 resistance level in the S&P 500 is going to be an important resistance level.

If stocks can break through and close ABOVE that level this month, then there is a strong chance that the stock rally will continue into March.

However, if the stock market fails to go and stay above 1975, then we could see lower levels in the stock market, and the panic sell-off will likely continue.

Right now there are other signs of market weakness…

Take a look at this chart of financial stocks:

Financial stocks ETF XLF

We can see that financial stocks have broken below their turbulence cloud (shown in blue), indicating strong market weakness.

Here’s something important we need to remember: we cannot have a strong stock market without the support of the financial sector.

If financial stocks are falling and cannot gather enough steam to rally despite last week’s strong comeback in the S&P 500, then this does NOT bode well for the overall health of the stock market.

To quote market analyst, Mark Cook: “We’re in a bear market and about to go over the cliff”

While I am not yet convinced that we are in a bear market, I do agree that it is too early to think that the “bull market has returned”. I think lower levels in stocks is still a strong probability.

Alessio Rastani is a stock market trader at www.leadingtrader.com

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