I’ve been getting a bit frustrated with the seemingly unfounded optimism that the talking heads of the market are pushing. It seems the current opinion is that last week was a big overreaction to what was merely some expected news of some slowing sectors of the market and that the global economy is still expanding at a healthy rate. Last week was no big deal. Each time the market has corrected this year, it has more than made up its losses. I’d like to present a more realistic view:
“…the sell-off the past couple of weeks has brought the market back down in line with the fundamentals. ”
“The sell-off the past few weeks is not an overreaction to credit concerns that creates another buying opportunity. It is a reasonable re-assessment of what had been unrealistically optimistic hopes for stronger economic and earnings growth in 2008.”
“A full blown credit crunch is unlikely, and we are therefore not adopting a bearish outlook for the stock market. But credit conditions have indeed tightened. ” –Briefing.com’s Dick Green
What we experienced last week was an appropriate reaction to the frenzied gains we’ve seen over the last few months. What we will be experiencing over the coming months is a sideways to down market with moves in both directions, but a primarily downside bias.
I stand by my view that the trickle down effect of rising energy costs and decreased availability of inexpensive credit will put more and more pressure on consumers, forcing them to begin scaling back on spending. These factors combined with the slump in the housing market will begin to hurt the general market with the non-necessity markets being hit first (retail, technology, home improvement, etc).
I made this observation the other day and I thought I’d share. It goes along with the idea that the market performs similarly during a decade long cycle.
2007 Weekly Dow Jones Industrial Average
1997 Weekly Dow Jones Industrial Average
It doesn’t take long to see the similarities. Now, lets take a look ahead into 1998…
So, volatility ahead? I feel strongly that we are going to be sideways to down for the rest of the year, but that this winter may bring more record breaking days. Whatever the case, its interesting to observe this kind of correlation in years.
I’m making the prediction that the DJIA is about to correct by about 500 points over the next couple months. Expect it to drop down to around 13,000 and possibly down into the upper 12,000’s.
There are a number of technical indicators that suggest this scenario. First, the RSI and MACD are both pegged at the max on the weekly chart. Second, we’re heading into the real summer period, post memorial day. Third, there’s evidence of a bearish divergence pattern on the DJIA daily chart. Fourth, there’s a nice bearish candlestick pattern forming on the daily chart as well.
I could be wrong, but I figure I’ll draw a line in the sand and see if I’m right.
When you’re trading (not investing) the market, it is critical to realize that short term (hours/days/weeks) stock performance is largely based on factors other than the financial profile of the companies in question. Some of the less obvious factors often include:
- Time of day/week/month/year
- Holidays, elections, other events of global importance
- The weather
While some of these might seem silly, consider the following:
Historically, the biggest market gains take place during the fall months. Historically, the worst performing months are those of the Summer. This actually makes a lot of sense when you consider that the summer is the biggest vacation period of the year. Lots of vacations means less productivity, less people trading, more people taking money out of the market so they can afford the nice beach condo, etc. All of these things equal low volume, which means a flat or down stock market. The fall is when people are done with summer and get back to work with a fresh sense of purpose. They put their money in and start trading aggressively again. Just how much of an effect can this have?
“Money invested in the Dow stocks in the “best six months” and then switched to fixed income in the “worst six months” over 56 years grew to $544,323. But money invested in the Dow in the “worst six” and then switched to fixed income in the “best six” compounded to a loss of $272.“
CNN Money
The important idea to grasp here is that there are many non-obvious factors affecting market performance in very consistent ways. Being cognizant of these factors is critical to understanding the market and trading effectively.
So, I suppose it takes a market plunge to draw me from my blog trolling. I feel compelled to share my thoughts on whats happening right now in the market.
This is normal. I know it may seem a bit unusual, but this is a normal market movement. Consider the following: In the last 2 years or so, the Dow has had 4 weeks with a loss of 300 points or more.
Last week we experienced a drop of about 550 points on the Dow for the week. Granted, this was a bigger drop than normal; however, you must also consider that this is uncharted territory for the market. People don’t know what to think of the massive gains we’ve experienced over the last year and a half nor the fact that we’ve been consistently posting record high closings. This uncertainty seems to be making investors nervous. Give them a potential reason to cash out of their holdings and they will likely take their profits. A typical market pullback occurs in thirds… 33% of the move or 66% of the move. What we are currently experiencing could just be a pullback… Given the 2000 point move that we’ve been in since July 2006, our pullback could be 600 to a 1000 points without being “unnatural.”
Last week we had the worst market day since 9/11. Take a look at the following Weekly chart from around 9/11.
There were a number of significant down weeks during that period. I want you to take two things away from this chart:
1. Many of the down weeks were substantially larger than any of the down weeks we’ve experienced recently
2. Even when the market was in a significant downtrend, each massive down week was recovered from in an amount of time proportional to the down trend duration. The market had fully recovered from 9/11 only 6 months later.
Whenever people pull their money out of the market rapidly, they have to do something with it. Most of the money driving the market is not going to leave and never come back when something bad happens. Those people will put their money back in. The smart ones will wait until the market hits bottom and then capitalize on the prevailing bad sentiment.
This is what I’m challenging you to do right now. Pay attention to the DOW and the news. Look for the bottom. Make a note somewhere the day you think the market hits bottom and then see how long it takes for the market to recover.
