The U.S. stock market’s huge decline on May 5 actually boosts the odds of a strong rally beginning soon, even if it won’t kick off a new leg of the bull market.
That’s according to Hayes Martin, president of advisory firm Market Extremes. Over the years I have reported on Martin’s predictions of market turning points, which overall have been impressive. (For the record: Martin does not have an investment newsletter; my newsletter-tracking firm does not audit his investment performance.)
It was just a week ago that I checked in with Martin, who at the time said that a strong countertrend rally in the 8% to 15% range could begin soon. I reached out to him again midway through the trading session on May 5 to see if his projections had changed in the wake of the Dow Jones Industrial Average DJIA, -1.30% gaining 932 points on May 4 and then giving all of it back (and then some) the following day.
Martin said the net effect of recent huge swing is to increase his confidence that this 8% to 15% rally could begin soon. “We’re getting closer with today’s action,” he said.
One reason for his increased optimism is what he terms “bottom divergences ”— by which he means occasions in which the market as a whole is behaving stronger than would appear when focusing on the market averages alone. Bottom divergences have bullish significance, just as their opposite — top divergences, when the market averages are painting an unjustifiably rosy picture — are bearish.
Martin’s assessment that bottom divergences have become stronger in recent sessions is based on a number of indicators, and it’s beyond the scope of this column to review them. But a good illustration of Thursday’s bottom divergences comes from comparing the performance of the S&P 500 SPX, -1.60% (which is capitalization-weighted and therefore dominated by the highest-valued stocks) with the equal-weighted version (as represented by the Invesco Equal-Weighted S&P 500 ETF RSP, -2.13%. In trading Thursday, the equal-weighted version was outperforming the cap-weighted version by 0.6 of a percentage point.
Similar divergences were evident in other parts of the market as a well. The equal-weighted ETF version of the Nasdaq 100 index QQEW, -2.89% was beating the cap-weighted version QQQ, -1.80% by 0.4 of a percentage point, for example.
Martin reiterates the cautionary advice he provided a week ago: Don’t get carried away if and when the market rallies. It’s most likely a counter-trend rally within a bear market, not the beginning of a new leg of the bull market. Martin’s best guess is that the rally will “provide another selling opportunity” to reduce equity positions.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com