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Barrons Says "Buy:" Is This Really The Bottom?   (March 5, 2007)

The latest cover of Barrons announced: "Stick With the Bull." A not unexpected reassurance from the cheerleading media, but you have to wonder: based on what? Rather than rely on a lot of hope--if the housing market holds up, if interest rates stay low, if China stops sneezing, if the yen doesn't rise too much, if corporate profits stay strong, if oil doesn't rise above $60, and so on--let's look at a chart. All the U.S. markets are tracing similar patterns, so let's look at a one-year chart of the Nasdaq.

There's no law which says market declines have to follow previous patterns, but it's worth looking at last May's swoon just for comparison's sake. I've drawn a line indicating the approximate parallel point in the May decline to the current decline: where RSI drops below 50, and where the MACD is dropping rapidly toward a negative reading.

The bullish pundits are announcing "the bottom" and "the correction has run its course" after a mere week; is there any evidence in the charts to support their claim? While the market could bounce, as it did twice on the way down last May and June, the actual bottom was about two months out from the point we seem to have currently reached. It seems a wee bit premature to be screaming "buy!"

Elliott Wave enthusiasts will recognize a classic 5-step pattern: 3 lows and 2 counter-trend rallies. The market seemed to bottom twice, but each time it quickly fell to new lows. MACD did not turn positive (bullish) until mid-August. With RSI below 50 and MACD below 0, there is virtually no technical support for the idea that the market is about to rally and erase its losses.

In all fairness, few if any technical analysts called last week's sharp decline, and no doubt many will hesitate to call for a definitive scenario this early in a decline. But the basic possibilities are limited to about three scenarios:

1. Last week was merely a hiccup, and the market will quickly recover and resume its steady upward climb. (Go team, go! Yea, Bulls!)

2. The long-awaited Bear Market has finally begun. Yes, there will be counter-trend rallies, but the trend has reversed--for months or even years to come.

3. The markets are in turmoil, and they'll decline until the economy proves itself capable of supporting increased corporate profits, higher employment, benign inflation and lower interest rates. If these conditions still hold in a couple months, the market will resume its euphoric climb; if they don't, then the decline will enter a new stage.

Which is the most likely? Based on the above chart, #1 is unlikely, and #2 cannot yet be known; #3 would more or less follow last year's decline as a template.

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