Stock Markets Nearing Important Bottom

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 |  Includes: DDM, DIA, DOG, SPY, SSO
by: Kunal Vakil

The stock market is nearing what I think to be a very important bottom. I believe that last week's options expiration-related short squeezing rally will lead into a pullback that will test or even break the recent lows at S&P 1200. If we get down there, I will be a heavy buyer from 1200 on SP all the way down to 1182 for an intermediate term (9 months to 18 months) hold. Some major buy signals are lining up here.

1182 represents the 50% retracement of the 5 year bull market run from the March 2003 lows to October 2008 top on the S&P 500. This market could run as low as 1165 but this move would be fast and most likely occur on an intra-day basis.

An internal washout in the broad market looks to have occured for a couple of reasons:

  • Panic as measured by the NYSE NEW LOWS set in a single day high an all time high early last week. Very bullish from a contrarian point of view.

  • NYSE McClellan Summation Index, which measures the internal health of the stock market through analyzing the advancers versus decliners daily, is a very reliable tool in identifying major stock market bottoms. This index hit its second lowest level since 1929. The 1998 bottom (Asian flu) produced an even lower reading. Again, bullish from a contrarian point of view.
  • AAII, which measures investor sentiment, is near an extreme level of pessimism. The last time we saw this proportion of bears in this market was 1994, right before the dow began its decade-long bull market. The number of bulls as polled by AAII is now at its lowest reading since 1995.
  • Volume on the NYSE has been crescendoing to record levels; indicating a real fear or panic.
An external washout (price deterioration) is now due. This should bring the final wave of selling, coupled with evidence of inter-market divergences. i.e., banking, housing, and some other laggards should show some relative strength for my theory to hold true.

The "news" over the past year has been nothing but bearish, day after day, suggesting that this time it's different. The market is never different. It repeats its patterns over and over again. The credit crisis, deteriorating dollar, high gold prices, and high oil prices are troublesome, but the market is a discounting mechanism which has already priced these fears into it.

There is always a crisis and it won't be handled any differently this time by the criminals on Wall Street. When I mention criminals, I am referring to the engineers of this selling. The same guys who distributed, or sold, their shares between March 07 and October 07 are now keeping a downward pressure in the market in order for them to pick up their shares on a huge sale. When they are done, they will remove that downward pressure and allow the market to move up effortlessly.

Now, there is a chink in the armor. The market will soon be entering a period of bearish seasonal tendencies in the August to October timeframe. While I do believe a robust rally will come out of the levels I suggested above on the SPX, I am not going to rule out an attempt to retest the general 1165 to 1200 area, come August-Oct timeframe. This time period also coincides with the nesting of the 9 month cycle lows, the last one being in January of 2008. The theory of a 9 month cycle is very reliable in identifying significant bottoms in the market.

However, once this is complete, the market should be allowed to run in earnest. Volatilty should remain very high for the foreseeable future.