As I wrote last March regarding the bubble in stocks, it is clear that this rally is a technical countertrend. Nothing goes straight up or straight down. This rally is strictly technical and is being driven because of technical trends. The fundamentals aren't there to make this rally permanent. Regarding technical trends, I have included a graph from my friend Tim Wood's latest newsletter. Tim shows the rising wedge pattern of the last three rallies since last July. Note the first chart on the right. Each successive rally has been weaker, including this one. According to Tim's work, which combines Dow Theory and Tim's own work on stock market cycles, there are three mitigating statistics that indicate a strong possibility for the current rally to fade.
1) This rally has yet to take out the December highs of 9,043.37 for the Dow and 954.80 for the S&P 500.
2) George Schaefer's 50% retracement rule regarding market corrections. The retracement rule states that whenever a primary movement is corrected by a secondary movement in the opposite direction, which fails to retrace at least 50% of the preceding move, then the primary trend movement will resume, in this case a bear market move.
3) Seasonal rallies that fail to rally to a level of at least 50% of the previous cycle decline end up failing. Tim found 14 seasonal cycles that failed to rally of which 12 occurred within bear markets. When this happens, Tim found the subsequent decline to average 27.61% with a 73-97% probability.
Tim's second chart shows the greatest hurdle for the stock market and its primary trend, which is the head and shoulders neckline for the S&P 500. The stock market has made the attempts at taking out this neckline including the current rally and has failed. The neckline of a head and shoulders pattern is a formidable obstacle and one that is difficult to overcome.
It remains to be seen if the Fed can inject enough liquidity in the system to overcome a bear market and create another bubble to replace what looks like a fading bubble in real estate and home refi's. [See updated Money Supply] This will be especially hard given the economic fundamentals, which have worsened, and the gross overvaluations in the stock market. P/E multiples of over 30 for the S&P with dividend yields of less then 2% are poor indicators of future returns.
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