GETTING TECHNICAL
Don't Ignore Last Week's Early Warning
By MICHAEL KAHN
The sharp fall-off in stocks should be viewed as a wake-up call for investors. The technicals suggest that a sharper correction lies ahead.
THE FINANCIAL MEDIA WAS all over last week's market slide, citing a 4% decline and the worst week since March 2009. I concur that it was not your garden-variety dip in a bull market.
While there are arguments, both technical and fundamental, why this presents a buying opportunity for investors with an intermediate-term time horizon, something is clearly different about this decline compared to ones during recent bull markets.
And it should be taken as a wake-up call that it is time to realize that the rally can soon give way to a significant correction.
One look at a weekly chart of the Dow drives this point home. Even a chart that covers the atypical action of late 2008 shows that trend changes usually begin with a big multi-percent weekly move (see Chart 1).
Chart 1
There are four notable occurrences of such a move over the past two years including the end of the spring rally in May 2008 and the end of the calm before the storm in September 2008.
More importantly, major changes are visible at both the March 2009 bottom and the end of the now famous" head-and-shoulders pattern that wasn't" in July.
In other words, the odds that last week's activity represented a true change in trend are pretty good.
The technical argument against this, however, is that market breadth remains fairly robust. Right up until the selling began, the percentage of stocks trading at 52-week highs was rather robust and typically this is a positive for the market. Breadth often deteriorates well in advance of major market tops as the soldiers (the followers) fall away before the generals (the leaders).
But as I wrote last week, there are other factors, such as poor market reactions to otherwise good fundamental news, that are weighing heavily on the market. (see Getting Technical, "Why Stocks May Fall Further", January 21).
Junk bonds, which had been superstars during the 2009 rally, took some big lumps to suggest that investors are starting to get a bit more risk averse. And some of the world's growth engine economies, specifically China and Brazil, have seen their stock markets make actual technical breakdowns (more on this in this coming Wednesday's column).
Basically, the environment for stock investors has changed. But before selling it all and heading for the hills, consider that nothing about the financial markets has been the same since the housing and credit crisis began more than two years ago. Whether you believe all the gains last year were artificial based on government stimulus or not, we have to be careful making sweeping conclusions about where stocks are heading.
I believe we are in the transition phase out of the bull market. But as was the case last July, everyone is focusing on the obvious. As we know, what everyone knows is not worth knowing.
To wit, support at 1030 on the Standard & Poor's 500 is crystal clear to anyone with even the most basic technical-analysis knowledge (see Chart 2). This is why we have to dismiss it as a likely downside target for the current decline, should it get some legs.
Chart 2
More likely, in my view, the market will trace out a pattern as it corrects rather than simply breaking a trendline and dropping to a target. This jibes with what many think will be a 2004-like ease lower before the next leg of the bull market continues.
I am a bit less sanguine on this and think the pattern will be sharper and steep enough to cause another round of fear in the minds of investors. A "here we go again" feeling would drive investors away from stocks, moving sentiment back down to despair and finally setting up that generational buy signal people thought we got last year.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
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