Markets are at a turning point – is another crash coming?
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Dominic Frisby Feb 03, 2010
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After last week’s dramatic sell-off in the world’s stock markets, the big question now is: is this just a healthy shake-out in an ongoing rally, such as we saw last June? Or is it the start of something worse?
There are some – and I am one of them – who feel that the enormous rally since March 2008 has been nothing more than a bear market rally. I believe we are more likely to re-test the lows of March 2009 before the highs of October 2007.
As I have noted before, there are numerous parallels between now, and the crash of 1929 and the subsequent bear market rally, which retraced 50% of the falls and ended some six months later in April 1930. Let’s take a look at them...
Markets are at a turning point
Nick Laird of Sharelynx.com emailed me this chart during the week of the US stock market between 1925 and 1934. It’s pretty clear where he thinks we are in the grand scheme of things – and what happens next.
There are other notorious bears, such as Robert Prechter, who subscribe to this highly pessimistic view.
The anatomy of each crash (1929 and 2008) was remarkably similar, in both duration and size. But the lead-ups were not. In 1929 the crash came straight off the highs. By contrast, in 2008 the indices had been in decline for almost a year before the crash started, while most stocks had been falling for a good six months or more before that. The financials, for example, capitulated in autumn 2008, but their decline began in late February 2007, some 18 months earlier.
There have also been similarities in the post-crash rebound. But whereas, at one stage, I thought 2009 would be a virtual repeat of 1930, it hasn’t played out like that. The size of the bear market rally has been remarkably similar, in that roughly 50% of the falls were retraced.
In 1929, the Dow Jones Industrial peaked at 381 on 4 September. It hit a low of 199 on 13 November. It then rallied to a high of 294 in April 1930, a 52% retracement of the falls. In the most recent crash and rally, from a high of 14,200 in October 2007 to a low of 6,470 last March, the Dow has made a 55% retracement to 10,730. But the duration of this rally – some ten months and counting this time, compared to six months then – is considerably longer.
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Its too risk to buy into this tired market
It’s interesting to compare the similarities between the two periods of history. Given that we face many of the same underlying problems (excess debt and leverage) now as in 1929, we can look at what happened then to get an idea of what might happen now. But you shouldn’t get too wedded to the theory that one will be a straight repeat of the other. There are plenty of other examples where the rallies following a strong decline, such as 1987 and 1998, have led to an entirely new bull market. People have made good money this last year. Many investors are feeling wealthy again. Don’t underestimate the power of such positive sentiment.
But having said that, while I am not as bearish as Prechter and others, I am not buying stocks here. There is too much risk to the downside. Look at the chart of the S&P 500 below. Technically, the rising trendline has been broken. The 55-day moving average has been broken and we have a ‘rising wedge’ formation. (Outlined by the black lines in the chart below). This is a bearish pattern, often found at the end of uptrends. Many traders use a downside break from a rising wedge as a signal to short sell, particularly when – as is the case here – volume has been falling.
I have made bearish calls on this market before and been wrong. But I maintain that this looks like a tired market that is losing momentum. The recovery of the last two days could be a normal correction of a short-term oversold condition, or it could be the start of a significant leg up beyond 1,150. I’m opting for the former. One clue will be how the market reacts to the 55-day moving average (blue line) when it retests it.
The dollar's rally continues
Meanwhile, the US dollar has been rallying. As we have noted before, if the dollar rallies, broadly speaking, everything else falls. I still have a target of 92 on the US dollar index. Here is an update of the chart I posed a few weeks back. There is a lot of resistance at the 80-81 area, but if we get through that, it could move up fairly swiftly.
Gold remains on course for $1,400
Finally, gold. We remain on course for my spring target of $1,400 an ounce. There are, of course, all sorts of things that could derail this – capitulating stock markets being one of them – but for now gold is behaving according to the script. (I have outlined this ‘up-move pattern’ in previous Money Mornings: What’s next for the gold price?)
I’ll have more detail on this in another Money Morning. But for now bear in mind that in the post-1929 environment, when gold was the number one asset class, the really big moves came from mid-1932 onwards, when the stock markets finally bottomed. So it may be that the REALLY big moves in gold – when it goes to silly numbers, as I’m sure it one day will – are still a couple of years away yet. For now, hang on to the bull and don’t let him throw you off.
My final chart shows Homestake, the leading gold miner of the day, vs the Dow in the 1920s and 1030s. It shows what can happen …
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