By Mark Hulbert
Eager-beaver bulls are jumping the gun in declaring that the Nasdaq has entered a new bull market. While the Nasdaq Composite index /zigman2/quotes/210598365/realtime COMP -0.11% has rallied more than 20% from its June low, a greater than 20% Nasdaq rally does not, by itself, guarantee that a new bull market has begun.
On the contrary, there have been a number of occasions during past bear markets in which the Nasdaq Composite index rallied by far more than 20%. There were three such rallies during the bear market that accompanied the bursting of the late 1990s internet bubble, for example. The most explosive of them occurred between early April and late May of 2001, during which this benchmark rallied more than 40%. I doubt that any investor who lived through the bursting of the internet bubble would look back and consider that rally to have been a new bull market.
It’s not just the volatile Nasdaq that has the ability to rally explosively during bear markets. The same is true for the more sedate, blue-chip dominated Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -0.93% . There are three bear markets in the calendar maintained by Ned Davis Research in which the Dow also rallied more than 20%. The most spectacular of those rallies occurred over a five-week stretch in late 1931, when the Dow gained 35.1%. That rally occurred during some of the darkest days of the Great Depression, and once again I doubt any market historian would consider it to have been a bull market.
Defining bull and bear markets is difficult
As this discussion implies, coming up with precise bull and bear market criteria is not as easy as you might otherwise think. Defining every 20% rally as a bull market and every 20% decline as a bear market leads to a proliferation of major trend changes that is unhelpful in understanding market history.
One approach that some have suggested in response is to give up trying to come up with precise criteria. Others reject this and have tried valiantly to come up with precise criteria. As long-term readers of this column know, I rely heavily on the calendar maintained by Ned Davis Research, which is the product of clear-cut and objective rules. Ed Clissold, the firm’s chief U.S. strategist, explained these rules in an email:
“A cyclical bull market requires a 30% rise in the DJIA after 50 calendar days or a 13% rise after 155 calendar days. Reversals of 30% in the Value Line Geometric Index since 1965 after more than 50 calendar days also qualify. A cyclical bear market requires a 30% drop in the DJIA after 50 calendar days or a 13% decline after 145 calendar days. Reversals of 30% in the Value Line Geometric Index after more than 50 calendar days also qualify.”
This discussion is important not just as a matter of accurate classification. It also serves as a reminder that powerful and explosive rallies are not uncommon during bear markets, and that it’s dangerous to conclude that they mean happy days are here again. In fact, as I pointed out in a recent column , explosive rallies are actually more common in bear than in bull markets.
It’s of course possible that the bear market ended at the June lows. The lesson I instead draw is that if you want to argue that the major trend is now up, you need to base it on more than the Nasdaq 20% rally over the past two months.
Otherwise, the bulls’ eagerness to declare a new bull market is a sign of little more than the “slope of hope” that bear markets descend.
Hear from Carl Icahn at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The legendary trader will reveal his view on this year’s wild market ride.