As a continuation from my last article on the rather moderate 2004 market correction/ milder bear market, this article expands on the behavior of stock leaders, looking at their role near major market bottoms that form after grave bear markets.
The 2003 bear market
Here, a case study of the infamous dot.com bear market, spanning 2000 to early 2003, will be used to drive home how true market bottoms can be spotted with higher likelihood and contrasted with fake-out bear market rallies heading nowhere.
This article demonstrates that bear market bottoms do not always occur right near the absolute price Lows on the market averages, but that they are always driven by a characteristic group of leading stocks. This stands in contrast to bear market rallies that bring about weak or thin leadership, leading to equally weak rallies that succumb sooner or later into another wave of selling in the market.
The market tempts with strong rallies
Any bear market consists of waves of selling, interspersed by rallies making consistently lower peaks in price. People who had bought into any of the dot.com bear market rallies starting in May 2000, January 2001, April 2001, September 2001 or October 2002 had been shaken in their expectations and frustrated by the market – the NASDAQ had sold off a mind-boggling 78% from March 2000 to October 2002, and most tech stocks that had led the late 1990s bull market had lost much more in value than that, never to return to the scene.
And buying into these fake rallies would have been tempting – the May 2000 rally lasted 15 weeks and ran up 41%, while the September 2001 rally regained a whopping 51% over a duration of 17 weeks. As can be observed, bear rallies can last long and stretch far, and institutional money managers trying to bottom-fish for bargains in the last cycle’s leaders give them the appearance of enough commitment to draw in a lot of inexperienced market newbies and even experienced participants.
The context of the false 2002 bottom
The total bear market decline had manifested in between 3 to 5 waves of selling, depending on what you count as a bear rally. In the end, the number does not really matter. This post should technically be called the 2002 bottom (absolute Lows), but the actual bottom was made in March 2003 – albeit not at the absolute Lows. The market does not play by anyone’s expectations, including the one that market rallies always start off the absolutely lowest prices made in the market averages.
In October 2002, price Lows were made (which in hindsight only could be marked as the absolute Lows), after which a volatile 37% rally occurred. This rally sucked in a lot of the few onlookers that had not thrown in the towel after now years of a down-trending market. However, it was soon succeeded again by multiple months of punishment and a painful 18% correction down to the final March 2003 bottom. The latter occurred at a local lower price Low which though did not undercut the October 2002 Lows. Insisting on an undercut biased many market observers to not pay attention to a new rally that ensued then and there, expecting that every bottom needs to show a clear undercut and shakeout below the previous absolute Lows.
Spotting the genuine bottom
In the dot.com bear market, any single bear rally had produced very few individual up-trending stocks that were not being crushed by the market. These could have been bought on the long side, such as the healthcare stocks DVA, TARO, or the defense stock LMT … but the odds would not have favored finding them. Getting stopped out (or worse, taking heavy losses by those that do not manage risk) on about 90% of new buys while hunting for the rare stock that might make a profit, is a common characteristic of a bear market. Such would have depressed a large share of potential profits made. In the stock market, it does not pay to go against the trend, be it the short-, intermediate- or long-term one.
Again though, the devil was in the detail. Not all, but the vast majority of stocks that tried to advance in those rallies, including October 2002, were of low quality (fundamentally and technically) and their advances failed rapidly. What made the difference in the end, when comparing the market Lows made during May 2000, January 2001, April 2001, September 2001, and importantly October 2002 and March 2003?
As before, the answer lies in the leadership of the market: Their fundamental prowess, and their ability to show up in numbers, assume strong technical positions in a still weak market, and to initiate and continuously support new advances in price.
As compared to previous rally attempts, the March 12, 2003 bottom was characterized by a large group of leading stocks displaying these characteristics. Strength was further indicated by the fact that they were from a broad variety of industries, including but not limited to: Retail, home building, education, telecom, internet services, e-commerce, biotech, commodities (oil, steels, fertilizers), and more.
As can be seen in the chart below, they initiated new advances from strong technical positions right around and after the market formed a local lower Low (but did not undercut the October 2002 Lows!):
- 2/4 eResearch Tech ERES
- 2/27 Schnitzer Steel SCHN
- 2/28 Coach Inc COH
- 3/12 Local lower Lows made on NASDAQ
- 3/13 Amazon AMZN
- 3/13 Omnivision Tech OTVI
- 3/17 Career Education Corp CECO
- 3/17 International Game Tech IGT
- 3/17 Netflix NFLX
- 3/17 Yahoo YHOO
- 3/18 Remark Media MATK
- 3/19 Teva Pharma TEVA
- 3/19 University of Phoenix Online UOPX
- 3/20 Hovnanian HOV
- 3/20 J 2 Global JCOM
- 3/25 and 4/7 Netease NTES
- 3/25 United Online UNTD
- 3/26 Sohu.com SOHU
- 3/25 Hi Tech Pharma HITK
- 3/26 Advanced Neuromodulation Systems ANSI
- 4/1 Dicks Sporting Goods DKS
- 4/2 Centex CTX
- 4/2 Sociedad Química y Minera de Chile SQM
- 4/2 Avid Tech AVID
- 4/2 AskJeeves ASKJ
- 4/3 Research in Motion RIMM (Blackberry)
- 4/7 Urban Outfitters URBN
- 4/15 Harman International Industries HAR
- 4/16 Sina.com SINA
- 4/17 SanDisk SNDK
- 4/21 Deckers Outdoor DECK
- 4/22 Gene Probe GPRO
- 4/23 JetBlue Airways JBLU
- 4/23 Cal-Main CAL
- 4/23 Faro Tech FARO
- 5/5 Apple AAPL
This is a list of only 35 of the many strong stocks demonstrating leadership just before and for the 2 months succeeding the market bottom, and it is a non-exhaustive one. Many more stocks drove and supported the market up with strong advances in the ensuing weeks, but they are too many to mention here.
The crux of the story though remains: A market consists of thousands of stocks, but a genuine new bull market needs to be led and driven by high-quality leading stocks in strong technical positions. If you want to outperform the indices and even most professional money managers, listen to what the leadership tells you … and what it doesn’t.
Digging these stocks out is not a magic feat. It takes time and effort to learn how to find them, and read them. And it takes time to learn what’s not important or even a red herring when looking for a bottom. In case you want to radically accelerate your learning curve, see in great detail on how to spot these leading stocks, and how to evaluate their price/volume action properly, check out my stock speculation bundle!
… And stay away from joining in the bear rallies and secondary corrections that is not supported by strong leadership. Enough said!
