We are at a critical juncture in the state of the market. A classical “Head and Shoulders” pattern has been traced by the three major market indices since 3/13/2007. All that remains to complete what could be a market top signal for the S&P 500 is a close below 1406.70, the close on 8/15/2007. A retest of that low on 11/26/2007 produced a close at 1407.22. The close yesterday (1/4/2008) was 1411.63!
If the S&P 500 has a closing price below 1406.70 in the next several days, we have a bear market signal. How do we know if a bear market is actually going to occur? My benchmark to confirm a bear market is a close for the S&P 500 below 1370.60, which was the intraday low reached during trading on 8/16/2007.
If the current situation is simply another (successful) retest of the 8/15 low, the coming week will see a market rally of a few percent. I do not feel a successful retest can be proclaimed unless the S&P 500 ends the coming week above 1450. A smaller advance must be viewed with suspicion and judgement reserved.
In August, the recovery from the lows of 8/15 and 8/16 saw the S&P close at 1411.27 on 8/16 and 1445.94 on 8/17. By Tuesday 8/21 the market closed above 1450. The high in October (the “Head” of the chart) was a close of 1565.15 on 10/9 and an intraday high during trading on 10/11 of 1576.09.
At the end of November, the S&P 500 reached an intraday low of 1406.10 and closed at 1407.22. Two days later it closed well above 1450.
The software for this Blog does not allow me to import my Excel chart showing the plot of the “Head and Shoulders” pattern. If you would like me to e-mail it to you, please contact me at firstname.lastname@example.org .
This discussion has been on purely technical observations, not economic analysis. What makes me especially watchful at this time is the confluence of a “perfect storm” on the economic side. We have a credit crisis, world-wide, still of unkown proportions. The US consumer, responsible for 2/3 of our economy, is extremely over-extended by falling home equity, record mortgage and credit card debt, high fuel prices (which may well rise further in the coming weeks) and rising unemployment. One important indicator is help-wanted advertising, which has fallen to lows not seen for more than thirty years. The possiblity of a recession has increased markedly in the past few months. Stocks generally do poorly going into a recession. The bright side is that they start doing very well once we actually are in recession.
How to deal with this? Be careful in making any new investments while this scenario is playing out. Trim positions that have had large run-ups in 2007. If you use stop loss orders to limit risk, tighten (raise) the stops. If you want to try some short term trading, look at ETFs that short various indices or sectors. Examples are SDS (200% short the S&P 500), QID (200% short the NASDAQ Composite), SRS (200% short the US Housing Index), SKF (200% short financials) and FXP (200% short the Shanghai Index). Note: Loss control is critical in using these highly leveraged, very volatile ETFs.