Stock Technicians' Verdict: Market Rally Will Continue

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Richard Drew / AP

Traders gather at the post that handles Wells Fargo on the floor of the New York Stock Exchange.

Wall Street's number crunchers are happy. Stock technicians, who use mathematical formulas as well as charts and historical data to figure out where share prices are headed, believe the market's rally that started in early March, and has pushed stocks up 36% in less than two months, is here to stay. They say stocks will rise another 10%, before the market stalls. That would leave the Dow Jones Industrial Average at around 9,200, or about where it was in early October, just after the initial $700 billion bank rescue plan was passed by Congress, though still well off the market high of 14,000 set two summers ago.

One of the key factors making technicians ebullient is that the number of stocks going up recently far outnumbers the number of stocks sinking. Last week, for instance, nearly 2,165 New York Stock Exchange traded stocks rose, while only 1,009 fell. Market technicians say that is good sign for shares because it means investors are optimistic about the fortunes of a broad range of companies and not just one sector of the market. Technicians also like the fact that historically most rallies last much longer than two months, and that the market hit its low twice, before rebounding. In the past, a so-called double bottom has been a predictor of the end of bear markets. (See pictures of the top 10 scared stock traders.)

In a recent report analyst Mary Ann Bartels of Bank of America/Merrill Lynch told clients she thinks the current rally is being driven by outright buying, and not just by short sellers closing out their positions which involves a stock purchase. "The market rally can continue," she says.

Once considered black art, technical analysis is now widely accepted on Wall Street as a method of predicting stock market moves. The problem is most technical analysis relies on measures of momentum. When stocks are going up, technicians tend to think that will continue, and visa versa. And in reality, that is how the market works. Studies have shown that stocks do tend to generally move in same direction for a while, before swiftly shifting course. But technical analysis can lead to overly optimistic views of the stocks at a time when they have been rising rapidly. And that could be the case now. The recent rally has left the Standard & Poor's 500 with a price-to-earnings ratio, based on an estimate of 2009 profits, of 15, up from 11 at beginning of March. That means stocks are relatively cheap compared to an average of the past two decades of about 20, but nearly as much of a bargain as they were when the rally started. Still, followers of technical analysis say there are a number of reasons to be bullish now. First of all, while stocks are up, they are still much lower than they have been recently. The percentage of stocks above their 200 day moving average, which is a sign they they could be overvalued, is just 30%. Back in 2007, when the market peaked, 80% of stocks were trading above that measure.

What's more, the current stock market rally is less than two months old. And most rallies at the beginning of bull markets have lasted much longer before stocks retreat. According to strategist Lazlo Birinyi, who has long used technical factors to determine whether stocks are a good investment, in 23 of the past 24 bull markets stocks have risen for an average of 194 days before falling more than 10%. That means the current rally, near 60 days, has more than six months to go, on average, before stocks pull back. "Absolutely, this is a bull market," says Birinyi. "The market is telling us that we got too negative."

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