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February 23, 2009

Facing the Abyss

In a post earlier this year I wrote that given my generally bearish slant on equities and the economy, I tend not to feel particularly disturbed by missing a big rally. I even feel relief despite having not profiting from the move. After all, rallies are just opportunities to load back up with shorts. However, I become quite agitated by missing a sell-off. Guess which state of mind exists today?

stock index chart

The good news is that we have now reached the target for the move off the January high... a possibility I mentioned over the weekend, but an outcome that agitates me nonetheless. Anyway, we should now see the bulls start a scuffle, if not put up a fight. The question is whether equities can muster enough strength to close back above SPX 805. Anything else is just a consolidation ahead of lower prices.

Whether it happens now or in a few weeks, I suspect we will see the SPX 800 level back-tested. It is simply too important a level on a historic basis. Remember the monthly chart posted a few days ago?

stock index chart

Just look at that chart! We've never seen anything like it in history. Eight of the last ten months have been down, and the two positive months were barely so. The total drop over those 10 months is just shy of 50%. Perhaps we work our way down to the SPX 690 pivot before performing the back-test. Ultimately, the S&P should unwind the entire tech bubble down to the high 400s. However, I don't see price going straight there. At some point, we should see some sort of powerful counter-trend rally to both relieve selling pressure and draw eternal bulls back into a delusional state. If the S&P falls straight to 500 then frankly, it won't really matter how much money we make on paper, because there might not be a system to hold the winnings.

The bad news is that a monthly close below SPX 800 severely reduces the odds of any rally posting a monthly close above that level for a long time. Maybe the bulls will muster a defense to close out the week. Such an attempt would be good news, even for bears.

A wise man in a movie once said that when a man looks into the abyss, there is nothing staring back at him. It is at that moment he finds his character, and that's what keeps him out of the abyss.

Will the stock market find its character?

 

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