Dow's Next Move: A Technical and Fundamental Look

The Dow Jones Industrial Average has until recently been closely following the roadmap for 2008 posted on 24th March 2008 as part of the Global Stock markets outlook, i.e. both the rally to early May to 13,136 and the subsequent downtrend to 11,700 by the end of June were virtually spot on. This was confirmed in the analysis of 3rd May 08, which concluded that Sell in May and Go Away would be a reality this year, as transpired during the subsequent decline into the end of June as the below road map chart illustrates from the March article.

click to enlarge

Charts courtesy of Stockcharts.com

However the breakdown below the support level of 11,500 represents a serious deviation from the anticipated road map which had originally called for a bottom to be made by now around a price of 11,700, against the last close of 11,100 on July 11, 2008.

While the absolute price is not important, what is important is the break of support, which implies weakness rather than strength for the next stock market upswing, that had envisaged a trend back towards 13,000 by the end of September 2008.

Therefore this analysis presents an update to the roadmap for the Dow to try and gauge the likely trend for the next three to four months that would take the Dow into late September.

Briefly - Fundamental Background

Fundamentally the situation has continued to deteriorate on the earnings front, with little sign of an imminent low either in the housing market or the banking sector, which on Friday saw the financial sector on the brink of collapse as Fannie Mae (FNM) and Freddie Mac (FRE) crashed by 50%.

The other major event since March has been the surge in the oil price which has carried crude oil from $100 towards the $150 target for the year in just three months! This is probably the prime reason for the deviation in the Dow's trend and worsening of the technical picture for the stock market ,which has triggered a technical bear market on a fall of 20% from the high. Therefore the crude oil price is an important factor in determining the future trend of the DJIA.

However, as I mentioned in the recent article 'Crude Oil Seeking Black Swan for Spike above $150 in Overbought State', we have the problem of a black swan event - namely an attack against Iran's nuclear facilities that would result in a spike higher that would be accompanied by a major sell-off in the stock market. The only way around this possibility is the need to arrive at a conclusion, and in that regard, my conclusion is that there will not be an attack on Iran and therefore the future trend in crude oil during the next three months will be orderly, i.e. based on technical factors rather than a Black Swan event.

Even so, crude oil will remain volatile due to the rumors of an attack which will make the stock markets volatile. Unfortunately these rumors could occur at inopportune times that may trigger sharp declines, which is to say if the stock market has fallen to support and a strong rumor occurs that spikes crude oil higher at the same time, then that would trigger a break of support which is precisely what transpired during late June.

So I also have to factor in the probability of rumors into the Dow road map - a much harder exercise than the orderly crude oil trend observed from March to late May, which was anticipated to significantly correct, and that never transpired.

Technical Analysis of the Dow and Road Map for July to Sept 2008

The current breakdown below support of 11,731 is undoubtedly bearish and thus implies a weaker trend. However the seasonal bias for an uptrend heading into the US election still remains, as the swing pattern observed to date still matches the expected trend. It's just that the timing and the magnitude of the subsequent rally is now in question.

Short-Term Trend

On Friday we witnessed how close the stock market came to a crash on the IndyMac (IMB) bust and Freddie (FRE) and Fannie (FNM) about to burn the house down. Therefore again, the technicals may be outflanked by Black Swan events.

On a short-term basis the Dow is oversold and the MACD is eager to give a bullish cross, which implies a rally is imminent. The immediate target for this rally is the down-sloping trend-line presently at 11,600 and then the 11,730 previous low, thus representing a healthy move of over 600 points from Friday's close. Beyond that we need to look at the longer term picture.

Long-Term Trend and Road Map

I cannot ignore the fact that we are now in a technical bear market, therefore the following rally is expected to be corrective. At some point, we are going to revisit the lows seen on Friday.

The MACD is undoubtedly oversold but bearish longer-term, i.e. it is confirming that we are in a bear market where the trend will be between oversold and neutral.

Elliott Wave theory failed on the upside peak to 14,200, which was at a Wave 7. However, the subsequent trend is confirming a bear market of three waves down, of which A and B have been completed, which again suggests that the current rally will be corrective in nature, with the Dow destined to revisit and break recent lows.

• A Break above 12,500 would be considered bullish and imply an assault on the 13,136 high.
• A break below 11,000 would imply a continuation of the bear market and start of the C wave decline.

In Conclusion

The DJIA is expected to make an imminent low if it has not already done so. The expected up-trend will be volatile, but targets a move to above 12,100 by September 2008, which represents a move of +1,000 from Friday's close. However, this is a much harder call to make than the one in March given that we are in an official bear market and so many potential Black Swan events exist, such as last Friday's near crash on the IndyMac, Freddie Mac and Fannie Mae events, and the ever-present risk of an oil price spike following an attack on Iran that will reassert the downward bear market pressure and lead to an earlier termination of the anticipated corrective rally.

Comments

[veeblefetzer]

Once again, analysis of the charts and trends continues to predict the future - until it doesn't.

[adan]

great info - thanks!

i appreciate the presentation of probabilities, with recognition of possible derailments

it may be the best people can do re the future, act on chosen probabilities til the information changes, then re-evaluate

thanks again

[LarryH]

Very informative piece. You have clearly stated the present condition; only time will show what the coming weeks will bring.

[ajhough]

Informative! I don't know when the bear market will end but certainly not until oil prices level off and perhaps retrace. Most of the gains in the past five or so years are gone and we will see more on the downside. We have been asleep at the switch for eight years.

[Chartist]

I've never heard of 7-wave Elliott Wave cycles. MACD is a trend indicator and can stay "oversold" as long as the trend is bearish. Oversold is a term better used with a banded oscillator like the RSI.

[trader717]

I know of the 5-wave cycles, but I have also never heard of the 7-wave cycles. If you do notice, the 5th wave up marked about the top, and then the Dow proceeded to trade in a range with a subsequent break below to form the first multi-month down leg A which bottomed in March. It was a good article to read. Although, you didn't provide too much into the fundamental aspect going on in the markets. You mentioned earnings, so a forward P/E of the Dow companies compared with historical forward P/E's can be important. Fundamentally, it is also not just our economy that is in a recession, but now European economies. Therefore, even companies with high international sales that have been holding the markets up as much as they could are going to see earnings deterioration.

In the end, yes a rally is highly probable and would be healthy, but the trend remains down and both technically and fundamentally, the markets are bearish. (by the way for all those technical analysis haters out there, I believe technicals have been more accurate recently as we had many analysts from top banks like Morgan Stanley and UBS predicting S&P over 1,700, when the technicals were showing a possible double top and a subsequent breakdown, I strongly believe in both technicals and fundamentals, but just wanted to remind the haters that both can work)

[Mahant]

Appreciate a very timely and focussed analysis. ANY MORE DETAILS ABOUT FUNDAMENTALS MIGHT HAVE VITIATED A STRAIGHT SHOT. Recession in european markets is definitely affecting and so is the inability of G8 to come together in solving turmoil in credit markets.

[mkttrdr]

Trader 717,
I like your stuff.
But me thinks this chart should go back to 1998 when you see we are still in a bubble/bear-who cares about new highs when the cycle runs 17 yrs on average.

The balls bounce, so play the bounce. Buy and hold only works going up. Trading works going both ways.

Play the averages-base hits baby!