Strong stock leadership is what forms market bottoms and launches sustainable market rallies, whether that’s after long-term bear markets or smaller downtrends (think moderate multi-week or -month corrections).
This was true for any historic bottom to date – you may look at 1933, 1949, 1957, 1982, 2009, and all the many many others. More importantly though, it will continue to be true in the future for market operators trying to pinpoint genuine market turns.
Understanding this concept and being able to both spot and interpret the action of the current leading stocks of the market is key for both outperformance and capital preservation, such as it is right now deep in the bear market of 2022.
Market trends vs. market gyrations
The message of this article is the following: If a market turns reliably to the upside, a group of leading stocks will confirm. If they don’t, then the rally will fade soon. Their success or failure to make a splash is among the most important observations that tip off speculators whether they should involve themselves in a budding market advance.
Looking from above, there is no such thing as ‘the market’. The market consists of thousands of stocks, going up, down and sideways at any given time. Human nature pervades throughout us all. We tend to react similarly to similar situations, thus market participants as a group often unknowingly operate in harmony. The results are gyrating waves of moves in the market averages, waves that can be mistaken as genuine new trends to the up- or downside.
Key in finding true market bottoms and new trends (and telling them from mere gyrations) is identifying stocks that should lead a genuine trend, and observing whether they truly behave to support that conclusion. Because a reversal from an established down-trend is much more than just a gyration wave that mysteriously and randomly happens to turn into a new uptrend.
Why is this so?
Leaders will lead
Money is what drives long trends – hence for a strong new trend to occur, a critical mass of capital needs to flow into (or out of) equities. When the right conditions align, the group of big market participants that control the most capital will always funnel it into the stocks they believe to be the best at that time. This produces heavy buying that can be spotted on the chart across the market.
The avid speculator does not try to spot the economic or social conditions that might lead to the market genuinely turning. He cuts out the middleman, and only awaits the big players to act in harmony on these conditions when they manifest. In effect, he does not wait for the cause of a new uptrend, but the symptom.
And a genuine new uptrend is heralded by price leadership of a set of high-grade equities. This is true whether the uptrend launches from a smaller intermediate market correction or after a longer bear market.
The market in 2004
To illustrate, let’s look at the NASDAQ in 2004. After a strong rally off the October 2002 bottom, the NASDAQ Composite declined by 18.6% over 140 trading days from January to August 2004. In hindsight it is easy to see that the downtrend consisted of 3 waves of selling, with temporary Lows/bottoms found in March and May 2004.
Interspersing bear market rallies, that here ranged 9-10%, can cause a lot of FOMO and impulsive actions in market participants in the hopes of a new uptrend starting. The clue to tell whether this is premature lies with individual stocks.
The few stocks that tried to start moves in either of these rallies broke hard quickly after, shaking those speculators out that were controlling risk, or causing larger losses for the all-too-often unprotected amateur. In fact, only a rare handful of resource stocks (rising oil prices 2004 to ’06) could successfully hold advances that started in those fake rallies, for example Southwestern Energy which is marked on the above chart (SWN).
The true bottom is made
When the NASDAQ Composite made a new Low on the 13th of August, it soon sprinted up again with conviction, with a strong influx of volume found early on, e.g. on August 18.
Here though, things started to change radically. The difference to the previous rallies was that a whole group of outstanding stocks had been assuming strong technical positions for the prior weeks and months, and were being bought up heavily before and around the market Lows. Check the chart above and the table below to compare their timing and gains achieved.
More importantly, this time these types of stocks were not sold immediately after starting their advance, as seen before. Large buyers were holding onto their shares, and acquiring more. Supply was scarce and demand high, driving their prices continuously up.
One of the earliest movers was TravelZoo (TZOO). Travelzoo’s fundamentals were strong, experiencing massive growth during and after the multi-year dot.com bear market. In fact, TZOO was one of the few stocks that had tried to move out earlier in the May/June rally in 2004 but the market had still held it back.
The success of the early stocks moving up without encountering resistance, including TZOO, was an inkling that the market quality was improving drastically.
A whole group of leaders appears
The NASDAQ advanced a strong 25% in about 5 months, until it’s next period of selling came in at the end of the year. But it was driven by more and more fundamentally strong performers moving out sequentially after the August market bottom. Many staged strong rallies in that short time until they took a break while the market experienced weakness again, and many rallied on for lager gains despite.
These included but were not limited to:
- SWN: June 16, making an massive 440% move
- TZOO: June 28 and 16th August 16, making a enviable 292% move
- ADSK: August 20, gaining 80%
- AAPL: August 23, a sizable 160% move
- IIIN: August 23, gaining ‘only’ 90%
- CBRE: August 26, running up 90%
- MNST/Hansen Natural: September 1, gaining unbelievable 1350% without coming close to any sell signals
- CME: September 7, initial 60% run, could be re-entered on a 2005 digestion for a monumental 310% gain
- FRO: September 7, with a 60% run
- GOOGL: September 10, with a gargantuan 325% gain
- SBUX: October 1, scoring 30% and just minimally outperforming the market
- LNG: October 5, putting in a strong 240% run
Note that all of these stocks were advancing right with the bottom or soon after. When trying to catch market turns, it pays to look at the best stocks of the day for signs of strength or weakness. But what does ‘best’ really mean? Quite simply, we’re talking about the next generation of stocks, the elite, virile, dynamic high-growth stocks that are assuming strong technical positions due to institutional support. Of course, you need to dig for these. Nothing’s for free in the market.
Do not put labels on the market
Back in 2004, with an 18% drop the market had not yet declined 20% and could not officially be described as a bear market, using the common definition.
Having looked at every market correction of the NASDAQ since its inception though, I emphasize the difficulty of deciding where a secondary correction ends and a bear market starts. People argue over whether this should be at a 12%, 15%, 20% or 25% decline. But in the end – does it really matter?
What does matter for that assessment is how the leading stocks of the last cycle behave. In late 2003 and early 2004, many of the past cycle’s leaders that had run off the 2002 bottom were climaxing and/or cracking hard. From this more organic definition, this was at least a bear market for a large portion of the equity market.
However, the terms of bull, bear, correction, rally, and so on, are arbitrary. As Livermore remarked, we should not employ them as absolute labels. He suggested to rather look at up-trending and down-trending markets. And it just so happens that both of such are always heralded by sets of leading stocks.
They are and will continue to be the best prism to evaluate market reversals – whether for major tops after a bull market, secondary corrections, major bottoms after year-long bear markets, or bear rallies after a few months of sideways or down-trending prices.
Discerning these stocks though, separating the wheat from the chaff, and proper interpretation of price/volume action can be challenging. Let me teach you how to do everything you need in great detail in my speculation bundle.
Be on the look-out for the leaders and their price/volume behavior, and
you will be light years ahead of even many professional money managers.
