Declaring the Bull Market Dead

This isn't a just a bull market correction in the U.S. It's the Year of the Bear.

Almost every equity index I follow has experienced a reversal, some from parabolic proportions. And as you know, parabolic formations never have a happy ending.

Yesterday, we heard another round of testimony from Federal Reserve Chairman Ben Bernanke. When asked about the economy and Tuesday's dramatic drop in the Dow Jones Industrial Average, he sounded like Kevin Bacon at the end of the movie Animal House: "All is well!"

Gentle Ben described the 2.2% preliminary reading of fourth-quarter GDP (revised down from 3.5%) as more in line with Fed forecasts and said that moderate growth is still expected in the months ahead. He prefaced his comment with one huge "if": if housing stabilizes. There are no signs of that, with housing starts at the lowest levels in 10 years and new-home sales down 16.6% below the 1 million annual rate at 937,000.

When asked about Tuesday's stock market meltdown, Bernanke indicated that he didn't see a specific reason for the decline and said that there were no concerns about liquidity. That tells me that the selloff was caused by a convergence of several issues.

In terms of the economy, Goldilocks is getting wrinkles, with the deteriorating housing market and plunging durable goods orders. The Chicago PMI reading came in at 47.9, with prices paid jumping to 63.2. These are signs that favor stagflation.

On Thursday, the FDIC issued a press release with the headline "FDIC Reports that Housing Slowdown Poses Challenge to Bank Loan Growth." The recent slowdown in residential construction could reduce the demand for mortgages and commercial real estate and construction loans -- activities that have been important factors in loan growth for banks and thrift institutions in recent years. I highlight the worry about commercial real estate, as that states that the economic dislocations are starting to spread beyond the residential market.

The charts also present a telling viewpoint. Just take a look at these and try to tell me "all is well."

First, check out the Dow Jones Utilities Index. It peaked between my quarterly and semiannual resistances at 493.34 and 507.00, respectively. To me, the 500 level on this index is like the 5000 level on the Nasdaq in March 2000.

The Dow Utilities

Source: Reuters

The parabolic for the Dow Jones Transportation Average peaked just shy of my semiannual resistance at 5280. Note that the 12x3x3 monthly slow stochastic has shown a negative divergence at the top.

The Dow Transports

Source: Reuters

And then there's the Dow Theory nonconfirmation:

The Dow Theory Non-Confirmation

Source: Reuters

A Dow Theory buy signal occurs when a new high in the Dow transports is followed by a new high for the Dow Jones Industrial Average. One of these signals occurred in October 2006.

There was a nonconfirmation in May 2006, as the transports reached an all-time high that wasn't confirmed by a new high for the industrials. This was followed by an 8.5% decline for the industrials and a 17.5% decline for the transports.

Last week ended with another nonconfirmation. Both the industrials and transports reached new all-time closing highs: the industrials at 12,786.64 on Feb. 20 and the transports at 5178.37 on Feb. 21. While these indices play hopscotch, it's important to note that a nonconfirmation occurs when the industrials don't follow the transports.

I follow the moving average formation of the Dow Jones Industrial Average to handicap the nonconfirmation. The Dow closed Friday at 12,647, just above the 21-day simple moving average at 12,643. Once the Dow broke the 21-day, the focus became the 50-day simple moving average, which quickly broke on Tuesday. The Dow had been above the 50-day since July 25.

The Dow is below the 50-day, which indicates risk is to the 200-day simple moving average at 11,774. As this occurs, the wall of worry gets too high for the Dow to close above that Feb. 20 high.

---

Richard Suttmeier is the chief market strategist for RightSide.com, where he writes the Small Stocks and Sector Report. Early in his career, he became the first long bond trader for Bache and later began the government bond department at LF Rothschild. Suttmeier went on to form Global Market Consultants as an independent third-party research provider, producing reports covering the U.S. capital markets. He has also been the U.S. Treasury strategist for Smith Barney and chief financial strategist for William R. Hough. Suttmeier holds a bachelor's degree from the Georgia Institute of Technology and a master's degree from Polytechnic University. He appreciates your feedback; click here to email him.