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In
my last Commodities
Outlook , I promised to take a technical look at the stock market.
Three weeks ago, there wasn't much going on and I didn't have much to
say about it, but I knew we were approaching a point of clarity. That
point is now here: A number of factors are converging this week that I
think will lead to a substantial reversal. While I normally don't like
to go out on such a limb, there are enough factors lined up this time
that I think it is warranted, and if I am wrong, it should be
immediately obvious. This week is do or die time for the market. Once prices break out of the Wedge downside, they usually waste little time before declining in earnest. The ensuing drop ordinarily retraces all of the ground gained within the Wedge itself, and sometimes more (p.189) From an Elliott Wave perspective, this is called a rising diagonal or an ending diagonal: An ending diagonal is a special type of wave that occurs primarily in the fifth wave position at times when the preceding move has gone "too far too fast," as Elliott put it…In all cases, they are found at the termination points of larger patterns, indicating exhaustion of the larger movement." (EWP , page 36) Furthermore, "A rising diagonal is bearish and is usually followed by a sharp decline retracing at least back to the level where it began." (EWP, p.39) To make matters even worse for the bullish case, the index is right at resistance provided by both the upper end of the diagonal, but also by the recent May highs. Sustaining an advance beyond this resistance will not be easy. And Friday's price action was weak: The market hit its high in the first hour of trading, then spent the rest of the day giving back its gains. Based on the indicators I look at, this market is overbought at multiple levels of trend: monthly, weekly, and daily. Like with Ford, all it needs now is a trigger to set it off.Fed Meeting Wednesday That trigger will most likely be provided by the Fed Meeting on Wednesday. The consensus is that the Fed is done raising rates, and when it comes to Fedwatchers, the consensus is usually right. I don't expect any surprises from the Fed on Wednesday. However Fed Meeting days are always among the most volatile and exciting trading days, producing huge intraday moves - usually in both directions - as the market digests the pseudo news of the Fed's decision. Since the consensus opinion has already been factored into prices, the market should sell off after the announcement. And if by some fluke the Fed decides to raise rates, the market is really going to tank. It is a lose-lose situation. Whatever happens in between, the market should end the day lower than it starts on Wednesday, and lower on Friday than it starts the week on Monday. (And if other market players have already come to this same conclusion, the sell off might start bright and early Monday morning.) Based on both the Elliott Wave interpretation and the classical technical analysis view, the swift decline should take the SPX back down to the 1230 area. Since there is a similar pattern developing on the Dow, the decline should bring the index down to the 10,750 area, with further bearish potential ahead on both indices. But what about the price of oil, you ask? Since it's falling, isn't that fundamentally bullish for the market? And since interest rates are falling, won't the housing bubble be able to reflate? The short answer is, no. Falling oil prices reflect falling demand, which signals a recession. And yes, the housing market may see a second wind due to falling interest rates, but it is likely to be no more than a dead-cat bounce. The top is already in. Caveat and How you'll know if I'm wrong At this point, I'd like to issue a very clear warning. I am not an investment advisor, I don't have a crystal ball, and the only account I manage is my own. I don't write a newsletter - the periodic articles I write are a way for me to focus my thoughts and help me figure out just what is going on in the market, and I enjoy the feedback I receive from readers. Nothing about the forecast I've laid out above should come as much of a surprise to anyone who follows the market and understands some technical analysis. Furthermore, we're in mid-September heading into October - one of the worst times of the year for the stock market. If I can see all this developing, plenty of other people can see it as well. In some ways, this all seems too obvious, too easy to be true. As John Mauldin put it in his most recent column, "The market…is designed to cause the most pain to the largest number of people." All of the above is my best guess, based on my experience, but it is all just a guess and I could be very wrong indeed. I think we're in for a big decline this week. However, if the market instead decides to power up through the May highs, we could be going much, much higher as a lot of people, including me, are forced to cover their shorts! At the end of this week I'll issue an update with an assessment of my prediction, and how things actually panned out. I'll either be crowing, or I'll be eating crow! Either way, it is going to be fun, and we're in for an exciting week.
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