Get Ready For the S&P 500 to Break Below 1200

If you’ve been following the stock market this week, you might have come to the conclusion I’ve come to after many years of study: The stock market is a pain in the ass.  Put another way, the day to day moves frequently make no sense.  Thankfully, they are mostly noise and it’s the trends that show themselves over weeks, months and years that are the most important.

Consider this week (S&P 5-Day Chart):

• MONDAY: Stocks surged at the open on the government bailout of Fannie Mae (FNM) and Freddie Mac (FRE).  Midday they gave back most of their gains before rallying strongly into the close. 
• TUESDAY: Stocks gave back all their gains from Monday on news that Lehman’s talks about raising capital from Korean Development Bank [KDB] had broken down. 
• THURSDAY: Stocks sold off powerfully at the open on analyst downgrades of Lehman (LEH) and general concerns about its viability.  Then they reversed course and rallied back to breakeven by midday before a furious late day rally put them strongly in positive territory.  The S&P 500 was as low as 1211 on Thursday morning and as high as 1250 towards the close. 

Like I said - it's a pain in the ass.

The S&P 500 closed at 1249 yesterday, which puts us pretty much right in the middle of the recent range marked by the 1200 intraday low on July 15th and intraday highs around 1300 from August 11 and September 2 (S&P 500 3-Month Chart). 

Where do we go from here?

Personally, I think the next big move will be down and will take us below 1200.  That’s because I think, to a great extent, the bounce off the July 15 lows has been exhausted. 

What’s driven the bounce since July 15 are the financials and retailers.  The S&P Financials (XLF) are up 25% and the S&P Consumer Discretionary stocks (XLY) 17% from July 15 to Thursday's close.  (Even with all the worries about Lehman Brothers over the last 3 days and the selloff in the investment banks, the overall financial sector is only down 1.8% Tue-Thu).  Check out Bespoke’s pretty chart that tells the story so well.  In fact, the S&P Homebuilders (XHB) are up 45% over the same period (see Bob Pisani, “Market Leaders: You Won’t Believe Them”, Trader Talk, Thursday September 11). 

My look at the charts tells me these sectors are overbought and their moves to the upside about over.  Take away the leaders of any rally and you kill it.

Can any sector replace them and power the market higher? 

One candidate would be the commodity stocks, including energy, which have been hammered during the course of this last rally.  The S&P Energy stocks (XLE), for example, are down 15.5% from July 15 through Thursday's close.  Other commodity related stocks and emerging markets whose economies are commodity dependent, like Brazil, have also been hit hard. 

These stocks are oversold at this point and seem poised to bounce (see The Market Speculator’s excellent posts on the coming commodities bounce: “Commodity Trades And Last Nights Game Plan from The Trade Report” and “The Only Way I Know To Trade Post-Boom Commodity Bust”).  However, the thesis powering these stocks higher for years has been destroyed.  Most now believe in a global slowdown that will hit international markets as hard as the U.S.  Any move in these stocks, then, is likely to be only a bounce and not the beginning of a new move higher.

Here’s how I see it playing out:

• The commodities and energy stocks bounce over the next few days - but those bounces only represent new opportunities to get short.  They won’t provide any fuel to push the market higher.
• The financials and retailers start to give back some of their phenomenal gains of the last couple months.  These two sectors make up 25% of the market cap of the S&P 500, and more of its volatility, and will lead the index down.

That’s why I think the market is heading lower in coming weeks, and 1200 on the S&P 500 will at least be tested, if not broken to the downside.

Disclosure: None

Comments

[John C. Lee:]

We may be starting a new leg down, but some of these idiots just love staying bullish. This rally is over: seekingalpha.com/artic...

2008 Sep 12 05:18 AM

[Fabien Hug:]

Makes sense. Very interesting comment.

2008 Sep 12 09:15 AM

[daytrader:]

to greg

great article!the path of least resistance is down.take away the leaders of any rally and you kill it.that you cannot dispute.also,geopoliti... only good news is no news.alot of bad news,weak fundamentals.i can see the s&p hitting 1100 by year's end.

2008 Sep 12 11:01 AM

[ain't no fo...:]

Unfortunately, there is too much free taxpayer money in the hands of the investment baks for stocks to break down here, which would be the best thing for the markets, as it would flush out the drain once and for all and set the stage for a recovery.

The Fed, however, in one of the many interventions and manipulations by the government in what are now decidedly NOT free financial markets, gave them hundreds of billions of dollars in discount window candy and they are now the largest day traders in the world, whipsawing these markets and taking a piece of each huge intraday move... this activity accounts for the spectacular 100+ point up and down days that we are seeing almost daily, and it is the only real source of profit these investment bankss have today.

Its their cash cow, and they aren't giving it up.

And the price they paid for that? Another one of those quiet little talks with Paulson and Bernanke, in the smoke filled back rooms of their clubs sipping brandy, whereby they get to play with the toys, but they better keep the market up before the election or there will be hell to play, and their little party will be over.

Thus, the frenzied trading whenever the market starts to roll over, and always the bid stuck under it at 11100.

These are desperate times and these are desperate people doing desperate things in the administration, in the the FED, in Treasury and in the executive suites of Wall Street, and the 300 Billion or so in discount window money they have been given to manipulate this market is a small price to pay for an election and the trillions of dollars that will provide to bail out the desperate.

2008 Sep 12 11:42 AM

[Distressed ...:]

I'm watching the 50 day/200 day cross to the downside w/ the indices, I believe it will happen.

2008 Sep 12 02:30 PM