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The unfolding drama of Stocks – more to come?

17 October 2008

The Technical Trader’s view:

It is worth studying the long-term chart with some care:

The Head and Shoulders Top has certainly overreached its minimum target of about 980.

The market has deeply penetrated through the support from the prior High at 954.

The 767 low has yet to be reached.

It seems to us likely that, in the absence of any other support of consequence, the market wants to test that crucial level.

If so, and that 767 level were to break, a perfect Double Top would have been formed. Check out the consequences of that....

If completed the Top has a minimum move down to 380 or so.

That’s a large move – which so far is purely conjectural.

But worth bearing in mind.

(Especially since the Nikkei has already traded very close (7710) to its 2003 low (7600) and remains very close)

In the S&P, what if the current yo-yoing around the 950 level creates some sort of a continuation pattern?

What are the chances of that?

The shorter-term Head and Shoulders chart in the Dec 08 contract has been driving the market over the last 15 trading days.

That H&S too, has achieved its minimum target - more or less the level of the larger H&S pattern in the continuation chart.

But the important question surrounds the unfolding character of the price action over the next few trading days.

Watch for a possible Triangle: we need another High - around 1000 would be ideal - and then a break of the lower diagonal that has already been created....

Watch and wait!

The Macro Trader’s view:
Equities are currently suffering one of their most volatile periods in a very long time. Traders began frantically selling stocks globally a few weeks ago as serious concerns emerged over whether the global financial system would survive in its current form and as a result the Dow Jones suffered its worst sell-off since the 1929 crash.

But as has been widely reported, the launch of a ‘Global’ rescue plan for the Banking industry has broadly allayed fears of collapse and on Monday of this week, the Dow Jones enjoyed one of its largest point’s rallies ever, with other equity markets following suit.

But the initial euphoria soon gave way to worries over global recession. Although the financial system was no longer deemed at risk of collapse, as governments pumped money into their ailing Banks via part nationalization, the plan was seen as too late to prevent recession in the developed economies.

Indeed, despite interest rates in the US of only 1.5%, that economy is now seen as recessionary and, along with the UK and Euro zone, analysts expect it to be a worse recession than any other post WW11. Interest rates are expected to fall further, including those of the US, possibly at this month’s FOMC meeting.

Despite the help given the financial system and expectations of further rate cuts, equities remain volatile. It now seems clear that the powerful rally in equities earlier this week was little more than a short covering rally, which turned negative on Wednesday.

And even though stocks are trying to rally today, they aren’t much above the lows of the week.

Looking ahead, we judge economic data is likely to remain weak: today’s US Housing starts were the lowest since 1991 which was the last deep recession. Yesterday’s industrial production and capacity utilization were also weak and the Fed’s Yellen and former Fed Chairman Paul Volker both said this week the US was in recession. Current Fed Chairman Bernanke is saying the US economy faces serious threats.

In short, the financial market rescue plan has prevented the Banking industry from collapsing, but the financial crisis had already been running for over a year, and so the damage to the economy is already done.

In the UK and Euro zone the situation has been made worse by the Bank of England and ECB keeping rates too high for too long as they failed to recognize the severity of the threat to economic activity until it was too late.

The current situation argues strongly for a continuing bear market in stocks and that is what we expect. Worse still, when the recovery does start it is likely to be anaemic, meaning it could take a long time before a solid Bull market in equities emerges.

Mark Sturdy
John Lewis
Seven Days Ahead

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