Get enough people talking about a theory and, in time, it becomes gospel. The latest “gospel” according to the community of technical analysts, has it that 2009 is looking a lot like 1938.

Since 1938 was, by all accounts, a very good year for stocks, the bulls have been big supporters of the conspiracy oops, comparison theory.

The comparison begins in 1937, a year in which the Dow Industrials fell 40%, from the August high of 190 (much like the highs set in August 2008) to a November low of 112 (similar to the November 20th 2008 bottom, precipitated by the collapse of Lehman Brothers).

Having established a near-term bottom in November 1937, the Dow quickly rallied to 130, and traded in a range (120 to 130) until March 1938. Again similar to the moves at the end of 2008 and into early 2009.

By March 1938, the market had become overbought and collapsed, taking the Dow down to 100 in March 1938. Similar to the lows recorded in February 2009.

The rally off the March 1938 lows took the market up 20%. In 2009, the market rallied more than 30% off the February lows. Just because the 2009 rally was bigger, it does nothing to discredit the comparisons. Writes Lawrence McMillan at www.optionstrategist.com, “those who claim similarity between the two years are not talking about matching exact moves, but rather the pattern of the trading.”

At this point, the US equity markets have experienced two weeks of consolidation following the 30% pop from the lows. It took more than two months of consolidation in 1938 for the market to work its way through an overbought condition resulting from a swift rally. Technical analysts are looking for a similar trend to unfold this year.

But the kicker for this comparison theory is yet to come. The real oomph from 1938 occurred from June to November, when the Dow surged an additional 21% to 158. Culminating in a 58% total return from the March lows to the November highs.

Translating that into 2009 numbers, and we could see the S&P 500 index (SPX) at 1068 by fall. That’s the comparable SPX value if we equate the closing low of 676 on SPX in March, 2009, with the low of Dow 100 in March, 1938. McMillan provides us with the other comparable Dow/SPX points as follows;

Initial rally after February/March 1938 lows Dow 120: SPX 811 (already passed this)
Initial peak in June 1938 at Dow 145: SPX 980
Final peak in November 1938 at Dow 158: SPX 1068

McMillan offers a note of caution for anyone intending to use 1937 - 1938 comparables as gospel. The 1938 rally did not kick start a bull market. Values for the Dow remained well below the pre-depression level of 380 level which occurred in 1929. “It [1938] was just a strong rally – part of a long bottoming process in the worst bear market ever.”

From an option traders perspective, two strategies come to mind. The first is a middle-of-the- road covered call strategy. Since you will be owning stock, you can remain invested through the summer, should the market rally as in summer of 1938. If the market treads water through the traditional lazy hazy days of summer, then the option premium will pay you to wait.

If you buy the 1938 scenario as gospel, then a long call position is the right approach. Pick your favorite index (XIU comes to mind) and buy at-the-money calls with a July expiration.