Stock Markets: Which Way José?

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The list of well-known names identifying value on the US stock market at current levels is growing by the day and includes the likes of Jeremy Grantham (GMO – “Careful buying is justified”), Warren Buffett (“Buy America. I am”), John Hussman (Hussman Funds – “Why Warren Buffett is right” and “How low, how bad, how long?”) and Barry Ritholtz (The Big Picture – “Another buy in”). Even perma-bears such as James Montier and Albert Edwards (Société Générale – “Turning more bullish”) are increasing their equity exposure, albeit only for the short term.

Edwards sees the S&P 500 Index finally bottoming at 500, Grantham expects an “overrun on the downside” to between 585 and 780, and Hussman “hopes” for a bottom between 600 and 780. Bennet Sedacca (“Living on a prayer” and “What would it take for me to become bullish”) similarly has an index level of 500 to 600 in his sight.

In the meantime, the S&P 500 has been forming a so-called “descending triangle” since the middle of October. A triangle usually is a continuation pattern, i.e. when its occurs in a downtrend the break is usually on the downside. Based on technical analysis, such a breakout would imply a downside target of about 680.

11-nov-sp.jpg

On the other hand (as a good economist will say), if a downside breakout does not occur and we see a reversal to the upside, a strong countertrend rally could surprise investors.

Marc Faber, author of the Gloom, Boom & Doom Report, sees such an eventuality as follows: “… when based on some factors (technical and fundamental) a market is supposed to break out in one direction (up or down) and the breakout does not occur or fails, a very strong countermove usually gets under way. For what it’s worth, I covered all my short positions before Tuesday’s (November 4) almost 900 points rally [on the Dow Jones Industrial Index] and increased my equity exposure to 10% of my assets. I would consider a move above 900 for the S&P 500 to be a confirmation that a temporary low is in place.”

However, Faber cautions: “… the call for a temporary rebound (lasting three to six months and up by 20% or so) does not imply that we have seen the ultimate low – although I would not rule it out entirely in nominal terms. But it is unlikely that we are even close to a major low in real terms! In fact, in real terms the market would seem to have further considerable downside risk.”

The long-term inflation-adjusted graph of the S&P 500 Index is provided below, courtesy of The Chart Store. This rather ominous-looking picture shows that the real S&P 500 has already breached its 2002 low.

Click on the image for a larger graph.

12-nov-2.jpg

Source: The Chart Store

Although the venerable Richard Russell (Dow Theory Letters) claims that “neither the duration nor the depth of a primary movement can be forecast in advance”, he does caution about the great false rally that followed the 1929 crash. “That deceptive rally took the Dow in April 1930, back to within 60 points of the 1929 peak. Following the April peak, the market crumbled as the Great Depression started. In view of that example, I will be very careful and suspicious of any large-scale advance from here. The quality of any rally from here should be examined minutely for any discrepancies,” said Russell.

In short, stock markets seem to be on a knife edge and the closing lows of October 27 (8,176 on the Dow Jones Industrial Index and 849 on the S&P 500 Index) are key levels on which to keep an eye. Suffice to say that extreme caution is still the recommended course of action.

 

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More on this topic (What's this?)
Stocks Higher 10-Years From Now
Bears Awaken From Their Worst Nightmare
S&P Triangle Formation Suggests Downtrend Will Continue
Read more on Warren Buffett, S&P 500 (SPX) at Wikinvest
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6 comments to Stock Markets: Which Way José?

  • Simon

    Thank you for this post Prieur. I am a learner. I have only been a serious student of the markets for a little over a year now. My 2 cents worth is that the market had given up the hope that the FED will be able to stimulate another cycle of credit expansion. But it has not discounted the full extent of the current contract it can’t because it doesn’t have enough information. The information does not exist anywhere. It doesn’t know how much more hedge fund liquidation will occur or the feedback loops that might accelerate that liquidation. It doesn’t know how far all the economies of the world, as interelated as they are with the precious financial system and the productive economy, will be forced to contract. It does not know what form any recovery will take or what the consiquences of an population aging and resource scarcity or at least the scarcity of the primary commodity used to harvest resources will be when growth re-emerges finally. Given the extreme risk eversion that is developing now I see lots of room to the downside. One thing that puzzles me is how much further can the dollar climb and what will finally cause it to begin its decent. What goes up must come down after all.

  • Frank Wordick

    Grantham says he is buying too early. Buffett advises us to help save America by using our retirement money despite the fact that Berkshire Hathaway is going to hell in a handbasket. Berkshire has had 4 back-to-back quarters of decline, the last one posting a reduction in profit of 77%. I’m sure he’d appreciate a little of your precious savings as they might slow Berkshire’s downward descent. Hussman’s writings can be used equally well by bulls or bears to talk their book, but check this comment out: “Between the point that a recession is well-recognized, and a short period before the recession ends [when a strong move upward almost always commences], the market’s direction is extremely variable”. How many people favor investing in an incomprehensible market? Edwards and Monteir, who are analysts who tell it like it is rather than how they wish it would be, speak for themselves. They say they are playing a hoped for rally. Is this bullishness? John Mauldin, whose opinion should not be trifled with, thinks we are about 5 quarters into a 10 to 12 quarter unwinding. One important point to keep in mind is that the market has been holding the previous (2002) support level of 7000. Therefore, it is possible, tho seemingly unlikely, that the present retreat is just a correction against the 2002-2007 upmove. But the fact that the market keeps bouncing off 8000 should be taken with a grain of salt. 8000 is an even number with lots of zeroes after it, meaning that it is considered to be a natural support level — by many technicians — independent of what the market is saying. However, if the market breaks 7000 on the downside, all bets are off. Anything could happen. The market could even return to square one. This possibility is actually being bandied about by certain unoptimistic sorts, who are too bloody scared to voice this possibity out loud, because in doing so they fear they could cause the market to collapse. I tell you this, because I think you should know what some guys in the back room, who don’t blog, are mumbling and whispering about. Technically speaking, a move back to square one is quite possible, provided the 7000 support level is broken. When I say 7000, I mean just that. Charting is not done on inflation adjusted numbers. Despite the fact that some mangled always bullish investors, who as Gary Halbertson has said got run over by a train, appear to be hoping and praying — and you know what Sedacca said about those two words — for a gigantic rally a la 1929, it is day by day getting to look more and more unlikely. As Sedacca also said, contrary to popular belief, markets sometimes go down and stay down.

  • [...] characteristics of the so-called descending triangle on the S&P 500 in a post of two days ago (Stock Markets: Which Way José?”), mentioning that a reversal to the upside often leads to a strong countertrend rally. A move [...]

  • [...] of the so-called descending triangle on the S&P 500 in a post of two days ago (“Stock Markets: Which Way José?”), mentioning that a reversal to the upside often leads to a strong countertrend rally. A move [...]

  • [...] against the primary trend. Caution is still warranted!” (Also, read my post of Wednesday: “ Stock Markets: Which Way José [...]

  • [...] I summarized my current views in a post (“Is Stock Market Rally ‘Real’”) on Friday: “Stock markets are caught between the actions of central banks, governments and the IMF frantically fending off a total economic meltdown on the one hand, and a worsening economic and corporate picture on the other. This situation has a ‘no-man’s-land’ feel to it. By all means try to play a possible nascent rally, but be cognizant that, failing further technical and fundamental evidence, you are trading against the primary trend. Caution is still warranted!” (Also, read my post of Wednesday: “Stock Markets: Which Way José”.) [...]

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