A Perfect Setup for a Stock Market Correction
by
Claus Vogt
Since there's no holy grail to analyze financial markets,
the best approach is an eclectic one. So I incorporate as
many tools as possible in my analysis, including:
Fundamental valuations, macroeconomic models, monetary and
fiscal policies, interest rate developments, sentiment and
momentum indicators, and chart analysis.
Major market turning points are usually characterized by
many of these tools. That was clearly the case in 2007
when everything fell neatly into place to call the end of
a bull market that had started in 2003.
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Bull markets don't go straight up. And this one is
no exception. |
To a
somewhat lesser degree that has also been the case
starting this June, signaling a medium-term up trend. And
that's why I still expect it to continue during the coming
months.
But
even the strongest bull markets aren't one-way affairs.
They're often interrupted by short-term corrections
typically lasting six to eight weeks with prices falling
10 percent to 15 percent. And right now I think such a
correction has just begun.
Here's why ...
All Major U.S. Stock Market Indexes Are
Bumping Against Important Resistance
These technical resistance points are important enough to
warrant the beginning of the first large correction since
this medium-term rally began in March 2009.
Let's start with the S&P 500 ...
As
you can see on my first chart, this index hit the
resistance line going back all the way to its October 2007
high.
Source: Bloomberg
This
trend line is very significant, because it defines the
bear market of 2007 to 2009 when the S&P 500 lost 57
percent. And I think it's highly unlikely that this
resistance line will be broken through on the very first
try.
It's
much more likely that the market — which is already tired
after the huge runup of the past months — will have to
retreat from here to gather enough strength to overcome
this technical hurdle.
Next, have a look at chart below of the Dow Jones
Industrial Average ...
On a
first glance you may think there isn't any resistance
below 11,000, especially if you only look back two or
three years. But if you go back a bit further, to 2005 and
2004, you can see the massive resistance around the 10,000
area. This marks the lower boundary of a very massive
trading range.
Source: Bloomberg
Next, the Nasdaq Composite ...
The
Nasdaq has already reached the equivalent of 1,200 in the
S&P or 11,000 in the Dow ... the short-term bottom of
2008, before all hell broke loose. This is a very obvious
resistance point.
Source: Bloomberg
Now,
take a look at the Dow Jones Transportation
Average ...
The
Transports are showing a huge topping formation that began
to form at the end of 2005 and lasted until fall 2008.
When it broke to the down side, a crash wave ensued.
As
you can see on the chart below, this index is now back to
the lower boundary of that huge formation, a classic
resistance area that's not easily broken.
Source: Bloomberg
Finally, let's examine the Dow Jones Utility
Average ...
The
Utilities have been relatively weak since their March low.
But they, too, are bumping against resistance now. This
index formed a very nice topping formation from 2006 to
2008, thus a bit shorter than its cousin, the
Transportation Average. But the result when it was broken
was the same: A market crash in 2008.
Source: Bloomberg
Even
though this index has risen much less than the others, it
has still entered a massive resistance area stemming from
its trading range last fall.
Five Different Resistance Patterns
So
here you have it. Five indexes showing very different
chart patterns. But they're all hitting major technical
resistance areas at the same time! This makes for a very
strong picture of a market that'll have difficulties
rising any further without a correction first.
In Fact, Other Technical Indicators Are Equally
Weak ...
The
whole technical picture has become very fragile during the
past weeks:
-
Volumes have been dismal: Declining when the market rose
and rising when it retreated.
-
Momentum indicators show multiple negative divergences:
They did not rise to new relative highs during the past
three up-waves in the market.
-
Market breadth shows a similar picture: The ratio of
advancing to declining stocks was lower at each of the
past up-moves in the market.
-
Put-call-ratios were back to frothy levels: The equity
only put-call-ratio fell to 0.52 a few days ago, a level
often associated with short-term exhaustion.
All
in all I get the impression that the first big correction
of this medium-term up trend is already underway. I expect
it to last until late November and bring prices back 10
percent to 15 percent.
However, I don't expect this correction to herald a major
trend change. Hence, I suggest you consider using it as a
buying opportunity.
Best
wishes,
Claus |
