Bulls Hold The Line - For Now

It looks like the other shoe dropped this week. Just when everyone thought that we may have heard the last of the financial sector’s woes, more bad news hit the wires. The question is how many more shoes are left?

For a time, the market shrugged off negative news. Starting last week though, the market was oversold and there was just too much negative news from the banks for it to ignore. For the time being, the bulls have held the line. Although there is still strong evidence to indicate a market bottom was established in November, that does not mean one should stay married to that opinion should conditions change.

The question that is constantly asked is “will there be a retest of the November lows?” The breaking of support this past week on all of the major indexes (8500 on the DJIA, 850 on the S&P 500, and 1500 on the NASDAQ) makes that more event more likely. However, all three also bounced back off support Thursday on noticeably higher volume- a slightly reassuring development.

Past studies of bear markets tells us an actual touching or undercutting of the November lows is not absolutely necessary. Some have pointed out the possible formation of an inverted head and shoulders pattern developing on the S&P, Dow Jones, and the NASDAQ. While this may ultimately occur, at this point it is mere fanciful thinking. The pattern would not be complete until the neckline is breached (see the charts below). Until that occurs, anticipating the move is a pure gamble.

The price action on Friday was also questionable. The candles formed by the DJIA, S&P 500 and NASDAQ (I will not bore anyone with the names of the particular candlesticks) demonstrates that buyers’ hearts are not into this recent reversal. Indecisiveness was further punctuated on the NASDAQ by the failure to pierce the 50 day moving average.

As can be imagined, there was a dramatic rise on the “Fear Index,” a.k.a. the VIX. The VIX cut through resistance at 45 and has now backed off after running into resistance in the 55 area. If the indexes do recede below the November lows, investors should look to see if the VIX can make a higher high. If it fails to do so, a positive divergence will have occurred- a positive sign for the bulls. If a higher high is made on the VIX, things could get really ugly.

When analyzing the markets, do not get too wrapped up in the headlines. Remember, bull markets do not begin when the analysts raise their price targets higher and higher, and the newspapers trumpet the beginning of “a new age in prosperity.” By the time the economy is firing on all cylinders and everything is great, the market will be ready to top. This time, just like all the other times, the market will rise before the economy improves. Keep this in mind that when the market finally begins to move.

Hopefully, the market will sort itself within the next two weeks. Studies that indicate that “as January goes, so goes the rest of the year.” Last year was a prime example of a down January resulting in a bad year for the bulls. Once again, caution is advised.

Disclosures: No positions held

Comments

[Lonestar1:]

Good article. Although my own bias is for the market to set a new deep low sometime in the summer months, the near term technical picture + a (false?) hope for 2H recovery should push the SPX above 944 we saw in the new year.

No certainty, always probability.

Jan 18 09:14 AM

[prudentinve...:]

It has become almost a given amongst most commentators that sustainable recovery begins in H2 '09. Perhaps it will, but perhaps we are in for a much longer bumping along the bottom.

There are too many structural imbalances and inefficiencies, both in the domestic and the global economic frameworks. I suspect these may take a few years to sort themselves out, and the final outcome is not yet clear.

Jan 18 09:55 AM

[sleepless_o...:]

Candlestick spinning tops are often seen near short-term reversals. In these charts there are spinning tops for Thursday and Friday. Implication is a short-term bounce is possible this week. Don't ask me to estimate the probability.

Jan 18 11:19 AM

[wundr:]

Next week may set the stage.
The bulls have beeen accumulating shares since November. Thursdays move was right around the line of support. Did anyone see the bounce once the DOW hit 8000? The entire market took off with a lot of volume behind it.
Shades of October 10.
The weakness of BAC and Citigroup is a little disconcerting. One of the criteria established for a serious crash is the failing of a large regional bank. We're looking at some large ones.Will there ever be enough money for the toxic mortgage problem? It is not over yet.

Two scenarios, IMO, are:

1. The market will rise on an Obama bounce starting net week, move up to around the early November high (for the final round of profit taking) after breaking the January high and then decline starting in the summer to test the November low.

2. The market will drop over the next wave of earnings, bad news from the financial sector, and overall pessimissim. It will happen very quickly. Profits will be taken by the bulls and capitulation will occur. The December high may end up being the a significant level of resistance in the future.
Both scenarios will test the November lows at some point this year.

Three significant wild cards in the whole thing are:

1. The Middle East. The real war may have just begun.

2. Deflation. There have been large inventories built up in almost every sector. Profits will be weak until they get worked through, but the process could be deadly.

3. 9/11 #2 (could be anywhere in the world if it is big enough).

I'm inclined to think there will be a decline.
The shorts have been taking a big stake lately.

Jan 18 11:39 AM

[Conan the B...:]

A descending H&S is certainly a possibility but I have a problem with the development of each of the Right shoulders. The longer the current sideways movement, the less likely these are actually H&S formations.

One can actually call the two highs which you call L,R shoulders, simply as, areas of resistance.

Jury is still out. Obama takes office, has the Market already factored this in?

Jan 19 10:27 AM

[Still Renting:]

Regarding inventories: Once they are "worked through" with deep price cuts, I would certainly expect that replenishing them will be at a lower wholesale cost per unit than that of the existing inventories.

Jan 19 03:15 PM

[wundr:]

Jun 7 09 5 months later:
1. The Obama bounce did not materialize in January but the first stimulus package was passed. The market dropped. The November low was tested and failed on Feb 27 09. A new low was established on March 6 09 @ S&P 667. Since then the market has rebounded with a dramatic up trend. At this point the January high has been retested and is showing signs of resistance. Prices have become a little over optimistic, many equities are showing overbought signals on the RSI and bolllinger band analysis. The rising tide has floated all boats. A correction is due. Will the market drop to test the March lows? Consider:

1. The financial sector has made a dramatic comeback. Credit markets are starting to thaw. TARP funds have been received keeping the banks alive. Stress tests passed well, even though some of the test scenarios were a little weak. Even more important was that the Mark to Market rule was revoked. Toxic waste has been hidden once again. Insurance companies have been able to tap TARP funds as well. Short term financials are looking better.

2. GM has filed for bankruptcy and will be allowed to reorganize. Chrysler may go under. Toyota has had bad earnings. Vehicle sales have been weak across the board. No good news here.

3. Crude oil has reached $70 per barrel. GS says $85. Prices at this level will have a negative effect on the economy. The summer driving season has begun and may not be as good as hoped for. Crude inventories have been increasing as well. Natural gas has been wallowing in oversupply and weak demand. There is some downside potential in energy.

4. Unemployment reached 9.4% this week. The good (?) news is that less jobs were lost than were expected. How much employment is seasonal or underemployment has yet to be determined. The stimulus package offers $64 billion in extensions above the standard compensation. A minimal life support level for the economy.

5. The dollar took a big drop over the last few weeks. Treasury rates are increasing. Commodities are increasing in value. Inflation may be increasing. Not good for the economic recovery.

The market is peaking. A sad note is that the average investor has been getting signals to buy again. Many traders have stopped buying at this level and are looking to go short. The summer outlook is for a small correction going into the fall earnings. Then the wheat will be separated from the chaff. Fall earnings may be a little weaker than expected. Weaker equities that benefited from the rising tide will decline due to profit taking. Some of the equities that have gone up the most are ones that were considered a questionable trade just a few months ago. There better be a good report from some of these to maintain their current price. Winter earnings will be the real factor. Any weakness will send the market lower, especially if the unemployment rate hits 11%.

So:
Short term: a small rise due to new money coming back in (too late) followed by a drop to SP 850-870, DOW 8100-8200, in a good scenario. Lower if the fall and winter earnings prove to be weaker than expected.

Due to the large amount of government intervention it is hard to say when the March 09 low will be retested. At this point it looks inevitable. There is only so much money that can be printed out of nowhere.

On Jan 18 11:39 AM wundr wrote:

> Next week may set the stage.
> The bulls have beeen accumulating shares since November. Thursdays
> move was right around the line of support. Did anyone see the bounce
> once the DOW hit 8000? The entire market took off with a lot of volume
> behind it.
> Shades of October 10.
> The weakness of BAC and Citigroup is a little disconcerting. One
> of the criteria established for a serious crash is the failing of
> a large regional bank. We're looking at some large ones.Will there
> ever be enough money for the toxic mortgage problem? It is not over
> yet.
>
> Two scenarios, IMO, are:
>
> 1. The market will rise on an Obama bounce starting net week, move
> up to around the early November high (for the final round of profit
> taking) after breaking the January high and then decline starting
> in the summer to test the November low.
>
> 2. The market will drop over the next wave of earnings, bad news
> from the financial sector, and overall pessimissim. It will happen
> very quickly. Profits will be taken by the bulls and capitulation
> will occur. The December high may end up being the a significant
> level of resistance in the future.
> Both scenarios will test the November lows at some point this year.
>
>
> Three significant wild cards in the whole thing are:
>
> 1. The Middle East. The real war may have just begun.
>
> 2. Deflation. There have been large inventories built up in almost
> every sector. Profits will be weak until they get worked through,
> but the process could be deadly.
>
> 3. 9/11 #2 (could be anywhere in the world if it is big enough).
>
>
> I'm inclined to think there will be a decline.
> The shorts have been taking a big stake lately.
>
>
>

Jun 07 02:42 PM