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Markets Should Bottom Soon

|Includes: EUO, PowerShares QQQ Trust ETF (QQQ), SPY

Markets fell hard on Wednesday to mark the sixth day of consecutive losses for the S&P 500. The continued sell off experienced by the markets made the current pre thanksgiving week one of the worst performing in history.

The Euro crisis and the political deadlock of the "super committee" are the culprits of the current sell off according to the headlines.

I attribute the selling to a macro problem. There is an ongoing deleveraging process in developed western economies that started in 2007.  Abscent of new monetary and fiscal stimulus ( QE2 ended this June and the US & European governments are cutting public spending) there is no fuel to boost short term GDP growth and the natural path to a protracted deflationary recession is resumed in the debt burdened developed economies. 

Since the US congress will probably not pass Obama's 477 billion "jobs bill", the FED is doubtful of launching QE3 and in Europe there is no agreement for a local QE and TARP plan, markets started to discount the deflationary-recession scenario and thus stocks started to fall.

Is the beginning of a downward deflationary spiral that will tank markets sharply lower?

I don't know, but this threat of market apocalypse has surfaced various times during the last 3 years  and has always been avoided, at least for the moment. Politicians will try to kick the can and avoid the described scenario for as long as they can.

From a strictly technical point of view, markets should be reaching a bottom soon. We are currently extremely oversold and the returns from similar conditions are heavily skewed to the upside on a short to mid term basis.

My personal approach of gauging the breadth and participation of the world markets, the market monitor, is showing that 90% of its components are oversold. It doesn't get more pessimistic than that.  The recent August and October bottoms were reached with similar readings.

Two other oversold indicators I track (charts by Decision Point) are also flashing an extreme oversold signal on the market. The % of S&P 500 stocks over their 50 day moving average is 10% and only 1.8% are over their 20 day moving average.

In the other hand, 93.6% of S&P 500 stocks are hitting the bottom of their trend channel.

You can observe that from similar levels in these indicators the market bottomed and had a powerful short term bounce or a significant mid to long term rally.

Another thing that is noteworthy is seasonality. The highest returns for the S&P 500 are achieved from the end of November till the end of the year.  Coupled with the oversold conditions, this also skews expected market performance to the upside.

In conclusion, the market should bottom soon and a nice rally is to be expected. For the swift trader this is an opportunity to make some trades to the upside expecting a sharp oversold bounce. During the last 3 months or so these type of trades have been the most profitable since breakouts have mostly failed.

A tell that would signal that the market is getting ready to bottom is to watch the behavior of the leading growth and momentum stocks.  As of late their performance has been dismal, but if you start to see that this group is holding up or rallying in a weak market, the reversal will be beginning.

Hopefully this time it won't be different and the world will not end during 2011. 

Best regards,

                   Victor Riesco