Friday, May 27, 2005

Bull Market Boxes for the Nasdaq Composite

The weekly chart above shows the action of the Nasdaq Composite index since the bull market began in October 2002. In this post I'd like to guess how far up the index will go before this bull market ends.

The essential first step in making any forecast is to find an appropriate analogy for the current market situation. In my opinion, it is the 1929-1932 bear market in the Dow that is the closest analogy to the 2000-2002 bear market in the Nasdaq. Why? Well, the 1929-1932 bear market lasted 34 months and dropped the Dow Industrials almost 90%. The 2000-2002 bear market in the Nasdaq lasted 31 months and dropped the composite 78%.

In September 1929 the Dow industrials established a high at 381 and fell to 41 in July 1932. There were two important bull market tops during the 15 years which followed the 1932 low. The first occurred at the 195 level in the Dow in March 1937 and the second at 212 in May 1946. The significant observation here is that 195 is almost exactly 50% of the bull market top at 381 while 212 is almost exactly the 1/2 point of the range 41 - 381 of the bear market.

What are the corresponding levels for the Nasdaq Composite? This average established its bull market top in March 2000 at the 5133 level and dropped to 1108 in October 2002. We see then that 50% of the high at 5133 is 2567 and I've drawn this level as the solid black line across the chart. The 1/2 point of the 1108 - 5133 range is 3120 and this level is the solid blue line across the chart.

From this simple calculation I am willing to surmise that the bull market from the 1108 level will end either near 2567 or near 3120. My own preference is the 3120 target and I have three reasons for this. First, the 2000-2002 bear market was a smaller percentage drop in the Nasdaq than the 1929-1932 bear market was in the Dow. Second, the Nasdaq is more volatile than the Dow or S&P and I think the 3120 target is more in line with the projections I have for these other two averages. Finally, I see so much bearishness among the public that it is hard to imagine that a move only to 2567 could induce even the modest amount of bullishness that I expect to see near the bull market top.

The red lines drawn on the chart above are the bull market boxes in the average. These are 413 points high. In January of 2004 the composite bounced off of the 1/2 point of the third box and reacted to the 1/2 point of the second. In January 2005 the average again bounced off of the 1/2 point of the third box but this time dropped only to the bottom of the third box. This is a bullish sign and portends a move above the January 2005 top.

I also want to observe that the Nasdaq composite has traded sideways for more than a year now. An upside breakout from this range is likely to carry the market a long way and this is another reason for favoring the 3120 level as the target for the bull market. Note that the top of the fifth bull market box is at 3173.

The Nasdaq composite appears poised to break out above its year long trading range and this breakout should mark the start of the second phase of the 2002-2005 bull market. My best guess is that by the end of this year or early in 2006 the composite will have risen to the 3120 level.

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