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Don't Let Rallies Lure You Into Danger

Desmond says that although there have been four days from December through January in which 90% of stocks were down and 90% of trading volume was down, "there is no tangible evidence yet to suggest that the desire to sell has been totally exhausted."

He says that his three most reliable indicators of major market bottoms, which have been developed and used at his firm since the 1930s -- are still halfway between their bull market peaks and the deeply oversold levels found at every major bottom since 1949. Thus, he says, the probabilities favor the continuation of a bear market over at least the next several months.

Desmond further notes that the most intense losses typically occur during the final stage of virtually every major market decline as a result of a wave of panic capitulation characterized by another series of days in which 90% of stocks are down. So, like Gartman, he urges his institutional clients to remain cautious and not be tempted to get involved in every little rally that comes along.

How often do these types of seemingly significant but ultimately costly rallies come along? Desmond says that between the 2000 peak in prices and his major buy signal in March 2003, there were a one-month rally, two two-month rallies and a six-month rally. And during the 1973 to 1974 bear market, there were three one-month rallies, one two-month rally and numerous multi-week rallies.

So Desmond says investors should be prepared for similar rallies within the current bear market, but be aware that they "end abruptly and are followed by intense declines that can quickly dissolve any gains." As a result, he argues, "the best strategy, for all but the most nimble traders, is to stay focused on the primary trend and to use countertrend rallies to build cash positions."

I agree with the viewpoints of Gartman and Desmond. Investors need to stay focused on the notion that any rallies that appear are likely to be mere jiggles within a bear market that is still gathering steam. My current estimate is that the recent rally is about done, though if you want to get long, my seasonal work, which is done in conjunction with Logical Information Machines, says your best bet at this time is natural gas, best owned through the exchange-traded fund U.S. Natural Gas (UNG).

When natural gas futures rally to a new 13-week high amid a rally in crude oil, over the next five weeks the futures have been up 92% of the time by an average of around 24%. Examples include August 2005, December 2003, February 2003, November 2000 and May 2000.
At the time of publication, Markman had no positions in stocks mentioned.

Jon D. Markman is editor of the independent investment newsletter Strategic Advantage . He also writes a regular column for MSN Money . While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.
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