Friday, July 18, 2008

The Almost Daily 2¢ - Twin Peaks?

Subtitle: Bounce or Bust?

The S&P 500 bounced sharply off of the 1215 level on the euphoric but shortsighted notion that Fannie and Freddie had been successfully bailed out of their current predicament.

Of course, the GSEs are no better off now than before the latest panic but Paulson and Bernanke appear to have succeeded in, at least temporarily, restoring a measure of confidence and stemming the tide of anxiety and dread.

So the question is … Are we headed back up to the 200 day simple moving average or will the rally fail prematurely as the news-flow further illustrates the ongoing and worsening effects of the recession?

My take is that stemming panic will always lead to a continuation and even an amplification of panic in the future. … This is merely a postponement of the inevitable and is possibly even teeing it up for a larger crisis.

There were REAL reasons to panic about both Bear Stearns and Fannie Freddie … the economic deterioration continues and these institutions are, in fact, essentially insolvent.

Postponing a full recognition of that fact does nothing to address the actual problems at hand.

There are a host of very interesting technical similarities (which are noted below) that indicates that we have fully entered into another bear market where on average the S&P 500 index retraces 20 – 30% from its prior peak.

It’s important to keep in mind that, at best, a bear market can be viewed as a transition into an period where there is a prolonged bias to sell into strength resulting in a successive series of lower highs yielding a clear downward trend.

At worst, there are periods (days or weeks) where particular stocks and the index as a whole will crash hard.

Study the following image (click for very large and clear version) of the S&P 500 index from 1995 to today then read below for the technical blow by blow.

Notice also, that I’ve added both the “effective” federal funds rate (light grey line) and an overlay indicating the period of the last recession.

As you can see, entering the last bear market, the Fed cut rate significantly taking it from 6.5% at the start of the bear market to 1.00% in the trough.

It’s important to note that although the Federal Reserve’s response was dramatic, the market still resulted in an over 48% decline.


THEN (1998 – 2000 Top)

  • A. October 1998 – S&P 500 gives early warning sign by crossing its 400 day simple moving average (SMA). Notice also that the 50 day SMA breached the 200 day SMA.
  • B. October 1999 – S&P 500 gives a second signal by crossing its 200 day SMA after a solid twelve month expansion. 50 day SMA touches the 200 day SMA.
  • C. Three prominent but decelerating peaks set up the top.
  • D. Between second and third (last) peak S&P 500 index breaches 200 day SMA. After the final peak S&P 500 index breaches the 400 day SMA.
  • E. 50 day SMA heads down fast and crosses the 200 day SMA. (Cross of Death)
  • F. 50 day SMA crosses 400 day SMA. (Cross of Far More Death)
  • G. 200 day SMA crosses 400 day SMA. (Cross of Fiery Gruesome Death)
NOW (Today’s Top)

  • A. June 2006 – S&P 500 gives early warning sign by crossing its 400 day SMA. Notice also that the 50 day SMA breached the 200 day SMA.
  • B. March 2007 – S&P 500 gives a second signal by falling near its 200 day SMA after a solid nine month expansion. 50 day SMA similarly depressed.
  • C. Three prominent but decelerating peaks set up the top.
  • D. Between second and third (last) peak S&P 500 index breaches 200 day SMA. After the final peak S&P 500 index breaches the 400 day SMA.
  • E. 50 day SMA heads down fast and crosses the 200 day SMA. (Cross of Death)
  • F. 50 day SMA crosses 400 day SMA. (Cross of Far More Death)
  • G. 200 day SMA crosses 400 day SMA. (Cross of Fiery Gruesome Death)
Although the recent, highly optimistic, Wall Street rally appeared strong, it’s collapse indicates that the prospects of a protracted bear market selloff is very real especially given the steady flow of poor macroeconomic, housing, consumer, retail sales and employment data that will continue to flow throughout 2008.