The Markets Slippery Slope

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Gabe Velazquez

04 Feb, 2008

in Indices and 1 more

First, it was Citigroup disappointing with their earnings shortfall, and this, along with less-than-stellar retail sales numbers for December, sent stocks roiling on Tuesday. The Dow and S&P finished the day lower by more than 2%. To add insult to injury, Intel's lackluster earnings release after hours pummeled those shares, setting in motion a plunge in the stock index futures. Translation - the market's in for more selling (at least in the early part of the year).

Can things possibly get any worse? Yes, they can. People seem to possess very short memories. After all, it‘s only been 4 years since we suffered through one of the worst Bear markets (caused by the technology-led recession) in history. How bad did things get then? From the beginning of the Bear phase in March of 2000, to the lows of August 2002, the Nasdaq Composite shed roughly 85% of its value. The S&P didn't fair much better, with a 50% trimming of its market capitalization. In the recession of the early 90's the aforementioned S&P declined by about 15%. Now, we have some statistics of how the market does in recessionary periods. The only unknown is whether the U.S. economy will contract enough to be categorized as a recession. Of course, nobody knows for sure, but the evidence is starting to mount in favor of one.

What strikes me as peculiar is that I've not heard one pundit or talking head in the financial media utter the words "Bear market". Perhaps this is due to the buy–and–hold bias most on Wall Street subscribe to. Or, maybe these folks are still in denial about what's going on around them, which ironically is partly why we're in this mess to begin with.

I've been getting plenty of e-mails lately from readers that are finding this market extremely challenging. In one category, there are those traders that have been trading for less than two years and are having trouble adjusting to the volatility of the past six months. In the second category, there are the "long-biased" traders. These guys and gals are accustomed to buying dips, with the expectation that if they hold on long enough, stocks or the markets that go down always come back. Shorting is not something they're inclined to do and are ill prepared to participate in. This type of market environment exacts harsh penalties on those players that are complacent, undisciplined, and inexperienced. If you find yourself in either one of these groups, your choices are not very complicated. You can stay sidelined until the market turns up and "live to fight another day", or you can seek the knowledge to trade in all market conditions. Then again, you can continue doing what you've been doing and hope that your funds can outlast your learning curve. I truly hope that you don't fall prey to the latter; as I've seen so many do in prior Bear markets.

Let's change gears now and move on to the charts. The first one we'll look at is the weekly chart of the cash S&P (below). What's noteworthy here is that in the face of all the horrendous news, the market has endured in the past month; the S&P has yet to breach either the March and August of 2007 lows (blue arrows). These technical footholds become extremely important and will come under intense scrutiny in coming days.

Next, we'll follow up with a weekly view of the ER2 (e-mini Russell). I mentioned last week that if this contract were unable to regain the 714 support level - that was penetrated last week - this would signal further weakness. We saw an attempt to rally late last week, but that attempt was quickly dashed. The ER2 now hovers around the 700 support level for now. If there was a case for a bounce, then this market needs to trade above this level for a few days.

Let's look at the hourly chart of the ER2 below. Here we can see the bounce and the subsequent failure. A quick point of interest: In Tuesday's rout, the Russell 2000 showed relative strength comparable to its big cap and tech brethren. The small caps - up to this point - have been the leadership to the downside. If selling in this group, along with the financials, begins abating, it's possible that another bounce is in store. This will be interesting to watch.

The Bottom Line:

Last week I had lessened my Bearish view of the markets. We did indeed have the bounce I was looking for and then the downtrend resumed. This week becomes a lot trickier as we have another wild card - earnings – to deal with. The market has become extremely oversold and sentiment is finally telling us that fewer and fewer people want to own stocks. This is good, if you're a long-term Bull. For traders that are shorting aggressively, be careful. I believe that there is an increased probability that the Fed will not wait until its scheduled meeting to ease monetary policy. Moreover, as the days pass and the market's prospects become gloomier, the pressure on the Fed to act will increase dramatically. My sense is that, just as they did back in August, they will succumb to the pressure once again. What will also be of interest is how the market finishes the day on Wednesday, after a gap-down opening (Intel's earnings miss). This type of market really keeps you on your toes and is what makes trading so fascinating!

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