The Current Uptrend Won't Last

The major indices have been grinding through massive sideways patterns in the last few weeks and are not at the threshold of a new bull advance. This sober point of view raises a number of assumptions about upside targets as well as the duration of the event before it runs out of steam and gives way to the primary downtrend in place since October 2007.

I believe the deep lows posted last month can hold for the rest of the year and into early 2009. But eventually, selling pressure will be too great and they'll break decisively, to the chagrin of newly minted bulls. That violation could easily carry to the 2002 lows on the S&P 500 index and Dow Industrials, where a long-term recovery may finally begin.

The spring rally gives us a good template for lowered expectations from now into early next year. That uptick lasted about two months and retraced 62% of the selloff that began in October 2007. The depth of bounce and its duration are typical in the early stages of a new downtrend. A 38%-to-50% bounce is more realistic at our current depressed levels.

The S&P 500 index sold off from 1313 to 839 in a two-month selloff ending Oct. 10. It's interesting to note this plunge was more vertical but shorter in duration than the selloff ending in mid-March. This sets up a scenario in which the major indices can post high-percentage daily gains but eventually underperform the prior recovery attempt.

S&P 500 Index

Click here for larger image.

Source: eSignal

The latest bounce just reversed near the 38% Fibonacci retracement at 1020. This is a natural turning point for a late-cycle countertrend rally, but the extraordinary nature of the October selloff, as well as positive seasonality from now into January, leads me to believe the countertrend rally will carry as far as the 50% retracement at 1076.

That level corresponds with the declining lows trend line, broken decisively in early October. The uptick would also lift the index far enough above psychological support at 1000 to encourage sidelined buyers to believe the bear market is over. Paradoxically, their capital is needed to trigger the next phase of this secular decline.

There are several other ways to view progress off the October lows and make logical predictions about when the ongoing recovery effort will finally end, Anecdotally, any uptick that lasts longer than the 44 days posted by the S&P 500 index during the March-to-May bounce will add a note of resilience to the current event.

---

At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

Farley is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product, The Daily Swing Trade, brought to you exclusively by TheStreet.com.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.