Saturday, October 18, 2008
Another wild day on Wall Street yesterday, although this time the swing was only 500 Dow points (the lowest of the week). It seemed like the market was going to take off in the mid-afternoon, only to get stopped cold and abruptly lose 4%.
Why did this happen? A look at the 60 minute chart shows that the downtrend line from the previous highs served as major resistance. The indices are forming huge symmetrical triangles. We should expect the S&P to fall to around 880 to test the lower part of that triangle. Then, the market will either: A) bounce up from there and try to break through the top part of the triangle again, B) bounce up and come back down again, or C) just fall straight through that downtrend line on this new wave down. The break of the triangle to the downside will trigger more massive selling. For conservative investors looking out more than 1-2 days, no major moves should be made until the triangle resolves to the upside or the downside. I can't tell you which way it will break, I can only tell you that when it does, it will cause major movement in the direction of the break. One pessimistic thing from a technical standpoint is that despite the very oversold conditions via a whole host of indicators, we cannot sustain a major rally. In the past 100 years, very oversold condidtions have always led to major snapback rallies. The 14% rally we had this past Monday may have been all the bulls can truly muster up. The other bearish problem is that these types of triangle resolve to one direction or the other about 2/3rds through the triangle, so according to my drawing on the chart above, we may have 2 chances at breaking to the downside but only 1 more chance (if we bounce up again) to break through the topside. These patterns do not keep going until the points of the triangle meet.
I mentioned that I had gone "long" the S&P and NASDAQ via the SSO and QLD. As I indicated in the comments section of "Double Bottom" yesterday, I got out of these positions late in the afternoon, as a failed rally on a Friday afternoon (and the downtrend line serving as fierce resistance), did not make me keen on holding long positions going into Monday morning. I'm sure that type of mentality among traders contributed to the decline in the last 90 min yesterday...who trusts this market? Bad news of failing banks, etc. tends to come out over the weekend and Monday's market could be ugly (again).
For all of you think that this technical analysis is baloney, let me point you to an interesting article today that utilizes fundamental analysis. In short, based on valuation, stocks are still not "undervalued". Based on data from previous recessions and stock market lows, valuations might need to drop even further, and estimates by these experts put the S&P in a range of 400-600 to get into the appropriate range (yikes). These facts are confirmed by the wise folks at Comstock Partners who also suggest stocks are far too overvalued (see text posted in the comments section for this entry...it's a bit long and didn't want to clutter the board).