Where is the stock market headed now? Last October in my stock market outlook (see below) I said the following: "Certainly the market may have a bit more steam for a few more weeks or maybe even a couple of months. However, with this type of chart pattern the party can end suddenly and violently to the downside so my advise it to be aware of this and postition your portfolio to protect yourself in case it does." Well the market did in fact move higher until early in 2011 and then formed a head and shoulders pattern on the weekly chart followed by a sudden and violent end to the bull run. This I think is the initial shock in what will be an ugly bear market. For now I believe the market will likely attempt to rally back into the 1,200 to 1,250 range on the S&P 500 index before beginning its next steep decline. It may not quite get that high though so use protective stops on any long positions you take should you decide to try and ride the rally because now it is a counter trend move. If this scenario plays out as I expect then that will be the last good chance to get out of the market before the carnage begins. Could this be wrong? Of course; nobody knows for sure what the market will do, however, I play the odds and right now I think the odds are high that the bull market it over. If the S&P 500 did manage to get back above the old highs earlier this year, around 1,360, then we would have to reconsider the situation and decide how to play the market from that point as it would be possible that the bull market is not over. If Bernanke decides to throw in a few hundred billion more for a QE III, which he may try to disguise in some way since this printing of money is becoming unpopular, then of course this might power the market higher for a while longer. But at the moment the charts suffered great damage in the last few weeks and will have tremendous overhead resistance in the 1,250 to 1,350 are of the S&P 500 index. In the end though I think we are headed for an economy that is going down into a double dip recession for sure and in fact the case can be made that we never left the first one since unemployment is still over 9.1% by the most generous measure during this so called "recovery" over the last couple of years. If this occurs then it is almost a certainty that the market will fall from these levels. In summary, until the charts provide evidence to the contrary I'm currently looking for a dead cat
bounce rally for a while and then another leg down in the market that will likely be much more brutal than the initial drop earlier this month. The head and shoulder pattern on the long term charts are still in place.
Take a look at these two graphs to see the head and shoulders patterns for yourself.
J. Cogburn Where is the stock market headed now? Back in the early fall of 2008 while the S&P 500 index was still over 1,100 I warned the market had formed a very ominous pattern and would likely decline violently in the near future. The formation was a hyperbolic rise with a double top stretching over several years. I explained that this is very powerful chart pattern that strongly suggested we were headed much lower. My specific prediction was that the market would rapidly move down to around the 850 level on the S&P, work there for a while, then decline to a level below 500 on the S&P before it was through. Well it did the first part as I had predicted, but after dropping off the 850 ledge it found support in March 2009 at a low of around 660 and has rallied strongly for well over a year now. This brings the S&P average back up into the 1,150 level and so happy days are here again, right? Investors and commentators are all excited about the next round of quantitative easing (QE 2) which the fed is talking about doing and the idea is that with all this money sloshing around the market has to go higher. Well perhaps it will..... but maybe it won't. The long term stock charts have now formed an ominous pattern that cannot be ignored that may prove to be every bit as bearish as the double top formation in 2008 that wreaked havoc on 401Ks and stock portfolios. But if the pattern completes as expected there will not be any major bounce within a year or two to pick up the pieces. Those who were long stocks and ride this market down will lose a significant part of their wealth forever. The pattern has now transformed from a "double top" in 2008 to a "head and shoulders" pattern now. Once the right shoulder is completed, and it looks like it may be almost finished, the next step in the pattern is a steep drop in prices. And it looks like a long way down from those tall shoulders on this chart. Could the market go a little higher before the pattern is completed? Of course. The right shoulder is not always formed at exactly the same level on the chart. But the point is that it has done enough work that it may be completed at any time. What about the election? If Republicans win big might this keep the market up longer? Yes, but it might also be a case of "buy the rumor and sell the news". Take a look at these two graphs to see the head and shoulders patterns for yourself.
Bottom Line: Certainly the market may have a bit more steam for a few more weeks or maybe even a couple of months. However, with this type of chart pattern the party can end suddenly and violently to the downside so my advise it to be aware of this and postition your portfolio to protect yourself in case it does. The financials collapsed in 2008 bringing the market down. Keep in mind that this mortgage foreclosure mess is threatning to bring them down again and their chart action over the last few days has been ugly. So this may be a hint that we are going to see some kind of repeat in this crucial area of our economy and the market. Those who have followed the tips on this site know we have been accumulating ETFs that rise in price as the market falls over the last few weeks. This is one way to hedge your bets if you are long other stocks or in fact make a lot of money to the downside if the market in fact takes a dive in the coming months. The risk with these trades is that the market just keeps on rising for months on end and never comes back down, but from our analysis above it is my opinion this is possible but it is also a low probability. Even in bear markets there are opportunities to make money. Click here to see our most recent stock tip. J. Cogburn The market normally looks a few months ahead and acts accordingly. In other words, if things are going to be better in 6 to 9 months from now the market will normally begin to rally. But does anyone really believe this economy is going in the right direction and will be better a few months down the road? Unless something changes we are headed toward one of the largest tax increases in history beginning on January 1, 2011. And the stimulus is running out of steam so states are going to be laying off employees before too long. I normally rely on technical analysis (chart reading) and that is why I predicted just before the market collapsed in 2008 that the graph looked terrible and we were likely going much lower. But let's consider one item here that is more of a fundamental data point. Consider the Price to Earnings (P/E) ratio of the SP 500. Bear markets often bottom out when the P/E ratio is in the 6 to 8 range. But we are still over twice that level now.... meaning to get to the historical bear market lows the market will likely fall much further unless earnings are so spectacular they bring the ratio down because happy days are here again. I personally do not believe the bear market that started in October of 2007 when the S&P 500 was over 1,500 (now around 1,070) will bottom out unless the P/E ratio is below 10 and most likely will get back below 8 before this bear is done. In my opinion what we have had during the last year is only a bear market rally and that rally is now over. Unless the S&P 500 gets back into new high ground for the rally that started in March of last year, which would be around 1,220, then we must assume the overall direction of the market has now moved from up (the last several months) to down for the next several months. This doesn't mean you can't have a rally for a day or two, but means it simply won't last once the bear is back in control as I'm afraid may be the case now. As you may know this past month was the worst May for the market since 1940. Take a look at the P/E ratio chart and decide for yourself what is likely to happen. If in fact the market is going to take us back to the old lows 401Ks will be savaged once again. But of course nobody knows for sure what the future holds, however, it would be wise for you to consider the P/E chart as you consider whether to ride out the market come what may or to step aside this time just in case we are in an elevator on the 15th floor and some clown has just pushed the parking garage button. Even in bear markets there are opportunities to make money. Click here to see our most recent stock tip.Stock Market Outlook
August 24, 2011
October 15, 2010
June 1, 2010