Before we look at my analysis, check out this graph courtesy of blogger Doug Short comparing the current market decline to the Great Depression.
(click on the chart to enlarge)
As you can see, the crash of 1929 happened more abruptly than the current decline. But in 1929, the initial crash was followed by a 10 month bounce where investors were not sure if the market was going to recover. Note that unemployment reached 8.7% in 1930 but still the market was able to stay above the 50% mark on the DOW for most of the year. Our unemployment level is still much lower than that today (at least officially). What this shows us is that even with very bad economic news, hope may last much longer than the market bears anticipate. Note also that there were a number of bounces during the 1930s decline that lasted 6 months or more.
With that background, let us turn to the current decline and examine what we might be able to expect going forward. For the big picture, let's look at a chart of the DWC over the last 25 years.
(click on the chart to enlarge)
The blue line indicates a "double top" (2000 & 2007). This was the first major resistance/support line in the 2007-2008 collapse. Bulls (investors and traders expecting the market to rise) made many attempts in 2007 and early 2008 to try to keep the market above this resistance line but ultimately failed in 2008. The failure to maintain a level above 14341 in early June confirmed that we had entered a massive bear market.
The red line indicates the bottom of the "dot-com" bear market from 2000-2002. The market first ran into resistance at this level in 1997 on the way up. From 2002-2003 the bears (traders and investors betting that the market will decline) failed three times to push the market below this level, finally giving up and allowing the bulls to have another run at the blue line.
The pink line indicates a support/resistance line of market indecision. The market has had trouble clearing this level both on the way up and the way down in 1997, 1998, 2001, 2003, and again in 2008. Notice the wild swings between the red and pink lines in 2002-2003. The market has experienced extreme levels of volatility between these lines already in the past couple of months and I expect this trading range to hold for at least a couple of weeks and possibly up to 6 months more before we finally break decisively below the red line.
The yellow line indicates the next major support/resistance line above the pink line. If we break above the pink line in the next few weeks, I think we might make it back to the yellow line before the next major down-trend begins.
The purple line indicates the next major support once the red line fails. There is clearly a long way down without much to break the market's fall once we clear the red line. This is a further reason why I expect it to take a little while to clear the red line.
Now let us turn to the bottom of the Dot Com bear market in 2002-2003 to take a closer look at those resistance/support lines.
(click on the chart to enlarge)
Note: the lines on the graphs are not in exactly the right place. Please refer to the colored numbers for specific support levels.
For starters, notice the wild swings between the red lines and the pink lines. Also note that the market tried 3 times to fall below 7273 and failed each time. I expect multiple attempts to fall below that level again this time around. Imagine placing a bet on which way the market was going to move during this time-frame in '02-'03. Every time investors thought they knew which way the market was headed, it turned around on them. This is what I would call a range of extreme market indecision. This time around it is much more likely that the ultimate direction is down, but it is very unclear how long it will take the market to come to that decision.
The yellow line is DWC 10,000, which has a lot of psychological significance, but was less important from a technical analysis (TA) perspective in 2002-2003 than the red and pink lines. (Usually the TA significance of a support/resistance line is determined by the number of times the market bounces off it.) However, the market did struggle with the 10,000 level a few times between 2001-2004, and as we will see below DWC 10,000 remained significant in 2008 as well. It is definitely possible that we will see 10,000 one more time before breaking through the red line decisively.
Let us turn our attention to 2008:
(click on the chart to enlarge)
Notice that all of the support/resistance lines that were significant in the 2000-2003 bear market became significant in the 2008 bear market as well. I have included trend lines in the above chart to help us see the overall shape of the decline more clearly. The initial primary trend is indicated with solid black lines. The more recent panic is indicated with the dotted lines. Neither of these trends will survive forever. When the market clears the upper dotted line, it will be a confirmation that the current market panic is over and the market will be free to bounce back and forth between the red and pink lines. If the market clears the pink lines, it gives us an indication that the market might try to rally all the way back to the yellow 10,000 level. At some point, probably at least a couple of years from now, the DWC will finally rally back above the upper solid black line (at a much lower level). This will be an indication that the bear market is probably over. I will not hazard a guess at how low that will actually be.
Finally, let us take a closer look at the last couple of months:
(click on the chart to enlarge)
Notice the significance of DWC 10,000 (the yellow line). The market tested the 10,000-10,269 every trading day between October 6-21 except for October 10 & 16. This was followed by another attempt November 4-5.
Friday was potentially a key reversal day for the near term. As you can see, the market hit both the lower dotted trend-line and the red resistance/support line on Thursday, and bounced up pretty hard on Friday. If I had to guess, I would have to say that the DWC will rally back to at least the lower pink line before retesting one of the two red lines. At that point, we will probably retest the upper dotted trend line. After that, it's back to the red lines or up to the top pink line (or the yellow lines) if the upper dotted trend-line fails.
I am not sure if this level of technical analysis works because everyone believes in it and trades accordingly, or if it is truly a natural function of our collective human psyche, but these support/resistance lines clearly have a track record for giving us insights into the probabilistic nature of market psychology. Of course no one can predict what the market is going to do with absolute certainty, but time and time again, technical analysis proves itself to be a useful tool coping with the market's seemingly chaotic nature.
I will likely stay out of this mess. I will either go all cash, or try to stay market neutral (a balance between long and short positions) throughout this period until we break at least a couple hundred points below the lower red line.
As a side note, so far my favorite alternative energy stocks have not rallied very hard, and I am concerned that a downtrend might still be intact for them. I have theories as to why this might be the case, which I hope to share in the next few days. I have a number of posts I am trying to get out and I am not sure when I will get to that one.
On the other hand gold stocks performed very well and Mish just posted that he thinks gold stocks are a good buy at these levels. Mish is a true expert in deflation and has written many times about how he thinks gold will behave throughout this deflationary period (such as here and here). More importantly, he called the top in gold in March when it happened. My IRA would be a lot happier right now if I had listened to him. I do not intend on making that mistake twice; I plan to buy more gold related stocks and/or ETFs this week. Mish has been almost 100% accurate about every twist and turn so far during this collapse. In addition to gold, he called the stock market top in real-time and has been absolutely prophetic with regards to real estate, the financial system, banks, consumer spending, unemployment, treasury bonds, the value of the dollar, oil prices, and many many other topics. Very few people alive understand the current crisis better than Mish. It is too bad Obama didn't think to do a little bit of research on who actually saw this mess coming when he picked his economic advisers; Mish would have made a great Treasury secretary.
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