Monday, August 08, 2011

Historical perspective on the Stock market and what's ahead. (UPDATE #3)

I know many of you are nervous today, quite expectedly, I might add. The downgrading of US Debt by S&P and Italy's debt crisis gives one pause. So please allow me the liberty to say that a major crisis has been expected for the past year. I am going to repost one of my blogs here and then add a CHART SHOWING FRIDAY'S CLOSE at the end with some additional comments. Here's what I posted October 16, 2010:

"I have been thinking about this post for a while. It was triggered by friends who see the stock market in diametrically opposed positions. It appears to look like a Bull versus Bear argument but it's really not. It is the difference between those who use Fundamental Analysis and those who use Technical analysis to make decisions about market direction and trading decisions and whether to Buy, Hold or Sell. In order to get at this problem, I must first explain the difference between both analysis techniques. For that I will use the 4th Edition book by Martin Pring titled, Technical Analysis Explained. It is considered the bible for those interested in Technical Analysis. I will not make this too lengthly, but it is important to lay this foundation before I get into where the market is going to go and why the opposing positions have the positions they do. I will conclude with a number of charts and some support for the idea that while the disparity will continue between these two positions, one position is going to lead the way into the future as it is doing right now behind the scenes.

Ok, here we go. "Technical Analysis in nothing more than a tool", says Martin Pring. But a very good tool I might add. "Technical Analysis is based on the assumption that people will continue to make the same mistakes they have made in the past." According to, "At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company's value. In financial terms, an analyst attempts to measure a company's intrinsic value. If the price of a stock trades below its intrinsic value, it's a good investment.

Technical traders, on the other hand, believe there is no reason to analyze a company's fundamentals because these are all accounted for in the stock's price. Technicians believe that all the information they need about a stock can be found in its charts.

So currently the argument, for those using Fundamental Analysis, goes something like this. The S&P 500, based on historic terms is trading at about 21 times trailing price-earnings ratio and therefore is cheap as an investment today. That compares to the historical average of 16.4 since 1881 and is at the top end of the range pre-2000. The S&P 500 is expensive on a long-term basis, but and this is the big but, inexpensive compared to the past ten years. (Source: Prieur du Plessis)

Technical Analysts say, "Look at the charts! We are ready to drop significantly!" What do they base that argument on? A Head and Shoulder chart pattern. Let's take a look at several charts and explanations of the Head and Should pattern from several sources. The first chart shows a Head and Shoulder pattern looking at Oil prices back in time with an explanation on how to read the chart information.

This second chart shows a classic head and Shoulder pattern on a usual uptrend similar to the latest market movement this past few years.

This 3rd chart depicts more closely, the current market trend of the past 20 or so years and how to determine how far it should drop, and shows the neckline to measure the amount of the expected drop.

And the last 2 charts show the Dow and S&P 500 for the past 30 years and the big Head and Shoulder pattern we are starring at as Technical Analysts. It explains why many from this camp are very worried about the future.

One other very important relevant piece of information, High Frequency Trading now controls about 70% of the market volume traded in a single day (Source, 60 Minutes broadcast of Oct. 10th). It has also been determined by the SEC, that the single one day crash on May 6th where the market dropped over 600 points in 15 minutes was caused by the High Frequency trades made. It was caused by an algorithm (a set of rules to be followed in calculations and problem solving by a computer). Since May 6th, the SEC has instituted trading curbs, which stop the trading in any security which drops 10% in a short amount of time. Since the trading curbs have been in place a number of times the market has had to be stopped because of similar algorithms by other firms had glitches. The market is not being run by the individual investor, it is being run right now by computers, which were set up by humans, who tend to repeat the same mistakes, as I stated in the beginning of this piece. This is why I like Technical Analysis. You know we humans are going to panic at some point in the very near future. What will be the trigger is anyone's guess. But I think any rational person would agree we are going to panic and we are all just waiting like deer frozen in the headlights.

It has been painful staying on the short side of this market recently, but it will pass. I wish it weren't so, but I am worried many are going to feel some really bad pain and they are going to say it was unforeseen. The Fed will be the first to use that excuse when it happens. Just watch!"

Now allow me to post a chart of the Dow from Friday and see how this played out as well as where we are now. I want you to look at what really transpired since I had written this post in October. The formation of the right shoulder and my pronouncement was premature. (See the label "Premature Call" on the chart) The shoulder had dropped some but then continued to rise as can be clearly seen to about 12,800 on the Dow. But we have now dropped down to approximately 11,300 and look like we may even test the 11,000 level today or within the next couple of days. This makes the October 2010 post more relevant now, if we indeed completely formed the Right Shoulder and are now headed down to break that neckline. It will take tome for this to happen, as it will happen with sharp drops and rebounds forming a zig-zag pattern, but I strongly believe it will. I was premature in my pronouncements on the decline in October, as I was in the run up in 1999 when I said the market was going to drop and suggested people might want to raise cash then. You know what happened in 2000. That was the Head formation.

I believe this market will start down but may end up before the day is over. So be careful out there.

Please remember one major, important point. That is, no one can time the market! It has as much to do with Social Mood as anything else. This should give you a clue as to what eventually needs to change here in America: Our collective Social Mood! Don't blame any Party for that and don't blame the President. It's all about you and me! Leave a comment if you like. Thanks for coming on this day particularly.

UPDATE: 8:45am PST

The Dow has dropped over 380 points but then came back some, but not less than losing 250 points. European markets also tanked today but the most significant data comes near the close for the DAX, Germany's stock market index. It accelerated its losses at the close and closed down over 4.5% by the close to close below the 6,000 level finally ending at 5.951. That will affect our close today. I now expect our market to accelerate the drop near the close today. It is now possible to go below 11,000 today, even while the G7 and G 20 are trying to assure nervous investors that they will do what necessary to stabilize the markets.

UPDATE 2: 10:33am PST

It appears that we will be testing the 11,000 level before the close today. While the Dow is down 335 points at this hour, that's about a 3% drop, the Nasdaq is down 4% and the Russell is down 5% at this hour. The S&P is also down 4% so far, so you can see the Dow is lagging the drop and if we do close like the other Indexes are currently at, we will break below 11.000, substantially. Of special note is that the volume is very high so far today at 229 Million shares traded with 2 hours still left to go in trading. Now the President speaks with Dow down 400 points.

UPDATE 3: 11:50am PST

After the President spoke the Dow closed down about 385, but in the last hour it has accelerated now to the Dow's new low today of down 605 points so far, which broke below the 11,000 level significantly to 10,839. Volume is now up to 285 Million so far.

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Blogger Enrique Goldenberg said...

Right on Charles


8:33 AM  
Blogger Charles Amico said...

This from my friend Tom, from the Memphis area via an email to me:

"This is a fine description, Charles. It helped me a lot. AND patience is the word for the day and days! "

9:40 AM  
Anonymous Anonymous said...

Thank you, I appreciate your knowledge. I am having the feeling that this drop will be a long drawn out process. Alot of money will be made as this plays out.

3:10 PM  
Anonymous Stock Market said...

very good post, i was really searching for this topic as i wanted this topic to understand completely and it is also very rare in internet that is why it was very difficult to understand

thank you for sharing this.


Stock Market

8:18 PM  

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