How Far Will Stocks Fall?

Last week a worse than expected non-farm payrolls report knocked the wind out of the sails of the stock market. The fact that the best performing index, the NASDAQ, fell 2.67% shows what a lousy week it was. Meanwhile, the unemployment rate, currently at 9.5%, continues its steady march toward double digits. Against this backdrop, it should not be surprising that consumer confidence, as well as the stock market, fell over the past month.

With the second quarter finishing up earlier this week it is understandable that some profits might be taken after stocks turned in strong performances. The S&P 500 gained 15% and the NASDAQ gained 20%. Ominously, oil gained 41%.

It is no doubt that stocks are now in a correction. The question is: How far will they fall? We look for clues in some of the charts that follow.

The view from Alert HQ --

Charts of some of the statistics we track at Alert HQ are presented below: (Click to enlarge)


The chart above shows our analysis of the universe of stocks we evaluate, roughly 7200 of them. It's pretty clear that weakness has persisted over the last few weeks and performance was at its worst during this holiday shortened week. As lousy as this chart looks, there are still roughly 60% of stocks trading above their 50-day moving average. Not great but not bad. Unfortunately, there is no sign that the deterioration in stock prices is slowing down. Indeed, in order to complete this move, it looks as if the number of stocks whose 20-day MA is above their 50-day MA needs to move lower before we start to see some recovery.

The next chart provides our trending analysis. It looks at the number of stocks in strong up-trends or down-trends based on Aroon analysis. (Click to enlarge)

Here we see the number of stocks in down-trends increasing handily; the total currently stands at about 28%. With the cross-over displayed on this chart, we are now in the unfortunate situation where the number of stocks in down-trends outnumbers the number of stocks in up-trends. It is surprising, though, that the number of stocks in up-trends actually ticked up slightly this week.

The following chart show SPY, the S&P 500 SPDR ETF. I have drawn two green lines on the chart: the horizontal one is a support line and the descending line shows the down-trend that is being carved out. Put the two together and we begin see a triangle emerge. Falling below that support line would imply that we could see another 9% or 10% decline from that level.

Click to enlarge:


Some bloggers are seeing a head and shoulders pattern developing on the S&P 500. I have circled the left shoulder, the head and what is starting to strongly resemble a right shoulder in light blue. The implication here is also for a 10% drop from the neckline which just happens to be the same horizontal green line forming the base of the triangle.

With respect to moving averages, SPY has dropped below its 50-DMA but is still above its 200-DMA. With the 200-DMA still clearly pointed downward, it's not hard to anticipate a continuing correction at this point

Conclusion --

Our charts show stocks caught in a reversal. The market hit a peak a month ago and has been steadily drooping since. Luckily the NASDAQ is looking much better than the S&P 500 so there is hope this correction will not be too deep.

Economic reports coming up this week are modest so it is unlikely they might light a fire under stocks. We will be seeing the ISM Services report, consumer credit, initial jobless claims, the trade balance and the University of Michigan consumer sentiment index. No big hitters like last week's non-farm payrolls report.

So we have had some unpleasant surprises in several economic reports while most others are slowing their deterioration or even starting to show some small amount of strength. In the meantime, stocks are in a down move that needs to play out before any recovery can begin.

I suspect there will be another week or so of weakness then we will need to throw ourselves on the mercy of earnings season. This week, earnings reports will be light but they will soon be ramping up as the second quarter earnings season kicks off in earnest. Until then, though, there isn't much to reassure bulls and the bears will most likely continue to brazenly roam the Street.

Comments

[AndrewBaker:]

We're headed for more than a 10% decline in my view. Now 900 on the S&P has broken, there is not much stopping it getting down below 800. Once there, it's likely to go down even further: let's see how long it takes to drop another 100 points, and take any stakes off the table whilst it's happening!

Jul 06 10:36 AM

[TurtleTrader72:]

If we were to use some gap trading strategies, we should see the NASDAQ fall to around 1550 and the S&P 500 to around 815 where these indexes left some 'unfilled' up gaps during their bull run. Up gaps are visual representations of excessive trading practices and almost always get filled at some point in time. Coincidently, these gap levels also correspond to the 50% retracement level on fibanocci retracement studies. Even the first fibonnaci retracement level of 38.2% sits at 845 for the S&P 500 which is significantly lower than its current level. Futhermore, the VIX is starting to indicate an incrasing level of fear in the market as investors are starting to purchase additional put options to protect existing long positions and/or profit from a potential downtrun. Although there are no guarantees, the combination of these three technical points support the idea that this correction could take stocks much lower than where they are today.

Jul 06 10:52 AM

[Mad Hedge F...:]

So what is your hard number? Now that we are solidly into a correction, I have been flooded with requests from readers to call the next bottom in the S&P 500. Well here it is. Brace yourself. Put it on a Post-it-Note on your computer. It is without a doubt and unquestionably going to be 880, 850, 830, 800, 750, 666, or 320. That last number works out to be 90% of the book value of the S&P 500, which was the low seen in the 1930s depression. Yes, that depression, not this one. You are really asking me to solve a one billion variable equation, because that is the number of direct and indirect participants in global stock markets. If the few green shoots out there start to die off, the meltdown in commercial real estate accelerates, the Fed missteps by draining liquidity too soon, or there is another unforeseen shock to the system, then you can go with the lower of these numbers. If we are distracted by the health care debate, emerging market economies continue to perk up, and this strength helps our technology stocks stay alive, then sleepy narrow trading ranges will dominate, and the higher support levels will hold. But no matter what happens, I will be able to come back to you in three months and claim that I was right.

Jul 06 11:37 AM

[Tack:]

The news pattern in downswings never ceases to amaze me.

As soon as the market appears to have peaked and entered a "correction," the newswires become flooded with negative and pessimistic stories that are short, or absent, facts and long on rumor, speculation, innuendo, or flat-out untruths. This usually serves --at least for a while-- to emasculate data, which has been far more positive than negative, as of late.

And, so the downswings run for a little while, data or no data, notwithstanding numerous positive reports on corporate earnings, factory orders, ISM indices, pending housing sales, credit spreads,, etc. Heck, in a particularly good sign, even, retail sales were up last month, while consumers were simultaneously increasing their savings (future spending).

Right now, with Q2 earnings season immediately around the corner, trends, charts and technicals are near worthless as prognosticators because the real corporate data, i.e., revenues, earnings and forecasts, will quickly overwhelm any technical issues.

So, ultimately, the bet, presently, is whether one expects these data and accompanying discussion to be positive or negative. If the former, this minor pullback will be stopped in its tracks; if the latter, the selling could amplify.

Jul 06 05:38 PM

[sethmcs:]

How far will stock fall? There is a strong possibility they will go up. Expectations are low. Many companies should be able to exceed expecations. Besides the potential future earnings of the S&P are a lot higher than they are valued today.

Jul 06 07:52 PM

[Andrew Butter:]

Nice article, it's not often you get technical analysts that can express themselves coherently in Plain English, (I think I understood at least half of what you were on about).

The conclusion was well reasoned and logical also.

But I think this is all a drift sideways building up for a modest rally, no chance in my view of a radical reversal.

Jul 07 04:03 AM