Cyclical Bear Sinks Claws Into Stocks

by Michael Kahn
Tuesday, August 9, 2011
 

With major technicals broken to the downside, the S&P 500 could drop another 9%, to 1040. 

Conventional wisdom says a stock market bottom is an event whereas a top is a process. It took eight months for stocks to figure it out, but the process now seems to be over.

Say goodbye to the bull market.

The question is whether this is a buying opportunity or the start of something bigger. From the evidence I see, the next phase of the secular bear market that began in 2000 is now underway, which means further downside risk. But the good news is that it should not be as severe as the last phases we’ve seen this millennium.

By my observation, secular bull and bear markets last roughly 18 years each. Within each, there are cyclical bull and bear phases that last only a few years each.

This is the framework now exerting its influence. Unfortunately for investors, getting a handle on what to do in the short-term is now made difficult by the extreme volatility of the day.

When markets move as quickly as they have this month, we have to step back from the fray. Short-term technicals must take a back seat to the news that apparently drives investors to different extremes of emotion on a daily basis.

While the ability of technical analysis to handle such short-term volatility may be limited for individual investors, it is still quite capable of outlining the intermediate- and longer-term.

We can start with the rising trendline that supported the rally from the 2009 low. For the Standard & Poor’s 500, that line was broken decisively to the downside last week (see Chart 1). It is the first signal that the major trend has already changed for the worse.

Chart 1

BarronsChart1-0809.jpg

In April, most market indexes hit major resistance, or areas on the chart that brought out aggressive sellers in the past. In 2007, at the top of the last cyclical-bull market, technical analysts noted this key level at roughly 1375. The S&P 500 peaked this year at roughly 1370 and that is as near-perfect as it gets over a four-year span of time.

For the bears, the chart of the Nasdaq is even prettier (see Chart 2). The symmetry in price action is remarkable in that both the 2007 and 2011 peaks are roughly equal. So are all of the major support and resistance levels between these peaks.

Chart 2

Barrons2-0809.jpg

The bottom line is that no matter which major stock market index we use, there is ample evidence that the top is in.

Next, we want to measure how far down the cyclical bear can take us. The goal is to find likely areas on the chart where sellers might become exhausted and buyers re-emerge.

For the S&P 500, we can use a simple technique of measuring the height of the 2011 trading range and projecting it down from the breakdown point. This points to the 1150 area as a minimum target for a first stop on the way down and the market sliced through it like a hot knife through butter.

While a reflex rally can begin at any time, there is reason to believe that this is not the end of the decline. Cyclical-bear markets last more than just a few weeks, so bottom fishers should be careful if they want to start trawling with their nets.

The next target is roughly 1040 and it is derived by taking the second multiple of the 2011 range height projected down from the breakdown point. Not coincidently, this is also roughly a 50% retracement, or pullback, of the 2009-2011 rally. There is also strong chart support from the post “flash-crash” lows in 2010.

The confluence of technical levels makes 1040 a compelling target.

If and when the market gets there, we can then analyze how it reacts. If it cannot find its footing then we can continue the measuring process for the next targets.

It is a depressing thought for most investors, but it is all part of the natural ebb and flow in the markets. And it is all part of the healing process leading to the next bull market.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We’ll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.

 

 

http://finance.yahoo.com/banking-budgeting/article/113283/cyclical-bear-sinks-claws-stocks-barrons?mod=bb-budgeting%20&sec=topStories&pos=3&asset=&ccode=

Tuesday, August 9th, 2011 Uncategorized

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