A Seeking Alpha blog post from mid-June entitled Beware of V-Bottoms describes why the nature of the June stock market low would provide important clues toward the market outlook for later in the year. Specifically, the article details, from the perspective of market psychology and big money flows, why V-Bottoms tend to be more tenuous than tested lows. As can now be plainly seen, the June low did, indeed, form a V-Bottom:
As can be seen, the V-Bottoms of 2010 and 2011 each gave way to lower lows later in the year. From the perspective of market cycles, each of these lows constituted the end of a weekly cycle, also known as an intermediate cycle low (ICL). The lows of June 2010 and October 2011 also represented yearly cycle lows for equities. As the name implies, these significant lows occur roughly annually (about every 10 to 14 months). Therefore, the next yearly cycle low is due sometime this autumn.
So from both the technical and market cycle perspectives, equities appear to be in jeopardy of suffering a more fervent selling event in coming weeks. As with the previous two declines into yearly lows, the mid-year ICL (V-Bottom) should fail, implying a move below SPX 1260.
This outlook dovetails neatly with the macroeconomic backdrop. European leaders have yet to enact any serious policy changes toward preservation of their union. Despite promises from the ECB to support banks, short-term Spanish bond yields remain near multi-year highs. Greece and Italy also continue to fail to strike a balance between stimulative economic policy and spiraling government debt. Inaction from all sides is sure to induce a more severe crisis once the European vacation season comes to a close.
Furthermore, despite a slew of poor economic reports, central bankers have little political will to fire up new counterfeiting operations. The combination of imminent crisis in Europe with the lack of a monetary tailwind could act as a trap door for equity prices in coming weeks.
However, once equities fail SPX 1260, central banks will be endowed with a renewed license to print. Depending on the extent of equity losses and the severity of crisis in Europe, the reaction from monetary authorities could be tremendous.
There is no way to forecast whether central bank reactions will be swift enough or large enough to preserve the cyclical bull in equities, thereby leading to higher highs in 2013. However, the technical picture can be reassessed in autumn once the accuracy of the current expectation set is known.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.