The Making of a Bull Market, Part 2

Below is a 4 series article discussing the common themes that leads to a market transition between bull-to-bear and vice versa written by trader/teacher Larry Connors which have been originally published on 5/27/2010 at tradingmarkets.com. You can find the original articles in its entirety here.

Let's look at the first 4 today and we'll then the last 4 tomorrow.

1. There is no rational economic reason for the rally.

Go to this website and you'll see this in action. This is from late last week titled "What the Hell Just Happened On Wall Street". Read the comments. Disbelief! How could the market rally over 20% on a few weeks with such dire economic news on the forefront? Just how stupid is the market???

The market isn't stupid. It does what it does. 20% ago it had factored in the worst. When the worst didn't occur it rallied higher. And if things even remotely improve, it will rally further.

Look at every rally off the bottoms for the past 3 decades. They were all led by journalists and analysts who were in denial. The lesson to be learned here is early in a bear market to bull market transition, there will be little if any economic reason to support it.

2. The semi's lead first.

Usually by a few months. They're usually the first sign of economic activity. Look at 2003 as the best example. SMH rallied a few months ahead of the overall bottom which led to a four year rally.

3. Every bear to bull transition is accompanied by the financials.

If the financials don't rally, there is no bull market. And this time it's obvious why. Money and credit make the business world hum. No money or credit and we get a major recession like now. Money and credit starts flowing again, the economy starts flowing. Watch XLF. It's the financial ETF made up of banks, insurance companies, and real estate. As it goes, the market goes.

4. Basic Materials usually lead also.

If they're not building, there is no recovery. This factor is not as powerful the semi's and the financials, but it needs to be watched. If basic material stocks are moving, it means products are being built. In a recession, few are building unless there is demand and orders. I watch UYM (the 2x Materials). It does a good job along with the semi's and banks telling us the upcoming state of the economy.

Keep SMH, XLF and UYM in front of you to watch the health of the markets. And understand that the stock market action in these three industries speaks louder than journalists and analysts who are struggling to make sense of "What the Hell Just Happened?"

To Be Continued...