Dow's Next Move: A Technical and Fundamental Look

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 |  Includes: DDM, DIA, DOG
by: Nadeem Walayat

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

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

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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

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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.