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June 11, 2008

Correction or Bear Market?

As expected, the S&P 500 fell away from its 65DMA today, clipping a healthy 1.7% off its value. Fortunately, I listened to my own advice from yesterday's post and shorted some S&P contracts last night. Today's drop helped make up for my ill-fated moves during last week's short squeeze. The move also brought us within 10 index points of the target for a correection:

stock chart

I know I'm getting repetitive, but it's an important point: the line in the sand is SPX 1325. There is a lot of discussion on various blogs about whether we have entered a new bear market leg or are just seeing a correction of the bounce off the March low. Should this move prove only corrective, I imagine we'll be testing 1325 tomorrow or Friday and then bounce solidly higher. If we are in a new bear market leg, we will probably move in a narrow range sideways for a couple days and then solidly break below 1325. The latter scenario would imply significant new lows for the S&P. By significant, I mean on the order of triple-digit losses.

The NDX is holding up fairly well and is still above its own 65DMA. It would make sense for this index to bounce off its moving average... or fail it... at the same time the SPX tests 1325.

stock chart

Banks continued their melt-down today, off another 3.6% collectively.

stock chart

If we see a back test of 75 on the banking index, it would present an alternative scenario for a new bear market leg on the SPX. The SPX could bounce off 1325 along with the BKX rising back to 75, but take a consolidative form for the move higher. In other words, the next bounce in the SPX could simply consolidate the move lower from May. We would then see the continuation of a major bear leg as the BKX plunged lower from 75.

As you can surmise, judging the fate of the general equity market depends heavily on the characteristics of the action over the next few days. Should be interesting.


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