Tag Archives: fibonacci retracements

Passing The Stress Test

DJIA

DJIA

SPX

SPX

Nasdaq Composite

Nasdaq Composite

XLF

XLF

 The real stress test has already happened, but these results won’t be publicly recognized. For the last few weeks, the major indices have tested upside resistance multiple times tempting the bears to get back into the game. The remaining uncertainty in the market is significantly less than at the beginning of the year, and the Government’s Stress Test and auto industry turmoil account for a large percentage of the overall market volatility. The results of the Stress Test have been delayed three days, to May 7th. The delay stems from disagreement between the banks and the regulators, and while only delaying the inevitable, is perceived as a positive. There is only one reason the banks would disagree with regulators over the results, because the regulators made a mistake, miscalculated or estimated incorrectly. If the regulators were to overestimate, the banks would never raise attention to it. The disagreement has positive market implications, particularly because most, if not all, negative news has been priced in. This week’s volume was below average, but this is to be expected. Smart money is either already long, or they are awaiting the results of the Stress Test so they can jump into the “healthy” banks. The bears had plenty of opportunities to take this market lower, but failed to succeed, even in the light of a worse than expected GDP.

The first chart is the Dow Jones Industrial Average over the last 20 years, monthly. The Fibonacci retracements suggest important resistance at 8240. Closing above 8240 resistance at the end of May would imply the market has its sights set on the next level, 9650. At the end of May, when the markets have closed above the 8240 level, the uptrend march will  continue. I can see the DJIA testing 10,000 during the summer, but do not expect this to last. Expect the DJIA to retrace all the way back to the 8240 level after touching 10,000. This retracement would be extremely healthy, and would establish a base, or support, on top of current resistance. Establishing support on top of previous resistance has bullish implications, and is exactly what each of the major indices is currently doing.

The second chart is of the S&P 500 over the last 10 years, monthly. The Fibonacci retracements again suggest we are approaching important resistance levels, 880. Closing above 880 for May implies 1014 is next. Again, after touching this level, I expect a retracement to 880. The third chart is of the Nasdaq Composite over the last year, daily. No surprises here, the Nasdaq is also nearing important resistance at 1760. Closing above 1760 for the end of a day would imply 1900. However, I expect the Nasdaq to fill the gap at 1950 before retracing. Depending on the relative strength of the market at this time, I do not necessarily expect the Nasdaq to retrace as significantly as the DJIA or SPX. The fourth chart is the XLF Financial SPDR over the last year, daily. Fibonacci retracements are deliberately not drawn here. Over the last month, the XLF has gapped higher and begun to consolidate. This consolidation is similar to what the indices are doing, except the XLF’s next move is contingent on the results of the Stress Test.

As I mentioned already, these results will eliminate a lot of the uncertainty surrounding the financial sector, and will likely be the necessary catalyst to lift this market higher. It is not a coincidence that the markets appear to be searching for a catalyst, especially since reasons for the market to trade lower have not caused any significant decline. Much of the negative news regarding the banks and any forced capital increases has already been priced in. Citigroup and Bank of America, 2 of the 19 banks preparing to receive results of the Stress Test next week, have been shorted heavily. Rumors turned fact concerning additional capital has hit both Citigroup and Bank of America hard, but most analyst do not expect significantly negative remarks from the Government. Citigroup has already announced the conversion of preferred shares to common at the conversion price of $3.25. The short interest in Citigroup is about 23%, and any relatively good news will cause a huge squeeze. I expect to see Citigroup double before expiration of the June option contracts. The open interest for the June $5 calls is over 1.7 million. The derivative markets are quiet indicators of what’s to come.

Markets do not like uncertainty, and when the banking and auto industry issues have been resolved, expect a continuation of this bull market rally. The three largest contributors to the recent market decline was housing, banking and the auto industry. The housing issues were resolved some time ago when the Government took control of Freddie Mac and Fannie Mae. However, it took until a few weeks ago to empirically support a housing bottom. The recovery of the banking crisis began with the failure of Bear Stearns, showed signs of improvement with the consolidations of Merrill Lynch into Bank of America and Wachovia into Wells Fargo, government intervention with AIG, and the collapse of Lehman Brothers. Thursday’s Stress Test results will conclude the banking industry’s roller coaster ride, and mark the beginning of the financial recovery. The finalization of  the Chrysler/Fiat deal and the restructuring of General Motors will consummate this entire financial crisis. Although it is clear that the auto industry was not initially involved in this crisis, the threat of systemic risk implied by the collapse of the industry exacerbated fear and volatility in the markets. As each of these issues are put further and further in the past, less overall market uncertainty and volatility will exist. This directly implies steady growth, in my opinion, similar to the growth seen in the 90’s. Low volatility and steady growth are characteristic of secular bull markets.

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Building a New Foundation

SPX

SPX

The SPX has broken out above the 877 Fibonacci retracement level. This is extremely bullish, and from a technical standpoint suggests the SPX is headed to 934. Closing above 877 is important and will confirm the suspected rally. I expect to see the DJIA test 9000 and the SPX to test 950 over the next couple of weeks. If the markets create support at the current levels, enough consolidation will have occurred to support a substantial rally in the near future. The talking heads on CNBC are finally catching on and have suggested the possibility of DOW 10k by the end of the summer. Please review my archived newsletter http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_4-7-09_%7C_Cautiously_Optimistic_2009-04-07.html, to see that I have been suggesting this possibility since April 7th, when the DJIA closed at 7790.

Here is one of the articles on CNBC’s website suggesting DOW 10k. http://www.cnbc.com/id/30478135 However, my reference is to the anchors on CNBC’s television show.

1000 Point Rally Coming

SPX

SPX

CBOE Volatility Index

CBOE Volatility Index

 Even though the DJIA has rallied just over 1400 points off of the March lows, the markets are setting up for another 1000 point run. The rally off the bottom was just under 22% in 30 trading days. Bears that are building short positions, are doing so under the false assumptions 1) the market is overbought 2) it cannot go any higher. These two delusions couldn’t be further from reality. Markets are never overbought or oversold. Maybe relatively overbought or oversold, but you show me a time period we are overbought, and I’ll show you a different time frame where we are oversold. For example, many bears argue the markets are severely overbought. I might agree that they are relatively overbought, but in the last year, they are most definitely still oversold. Saying the markets cannot go any higher is the same mistake many people made on the way down from 14,000. At 10,000 I heard many people saying, no way we can go any lower. Wrong. This time is no different.

The SPX chart above illustrates the markets are in the middle of the channel, and currently neither too “overbought” or “oversold.” This chart illustrates why the markets are headed much higher: higher lows and higher highs. The pattern of higher lows and higher highs is extremely bullish. In keeping with this pattern, the next time the SPX touches the top of the channel, it will happen above 875, I expect this to happen around 900.

The CBOE Volatility Index chart above supports the uptrend. The CBOE Volatility Index is commonly referred to as the fear index as it reflects the implied volatility of the S&P 500 index options. The down trending channel suggests fear and uncertainty are leaving the markets. It should also be noted that the index typically trades within a channel, usually a horizontal channel. The fact that the index did not breach 40 today is extremely bullish. Previously 40 had been support. Now 40 is resistance. The translates into further extensions of this rally. Today’s market movement was healthy and very indicative of bull markets. Bull markets see many smaller up days and few larger down days. Until early March, the scenario was reversed. Before March, up days were large and there were many more down days. The Fibonacci retracements show 33.22 as the next support level. On Friday, the index traded very close to this without closing below it. Based on the retracement pattern, if the index closes below 33.22, it will trade towards 17. If the index touches 17, I will guarantee the DJIA is at least 1000 points higher.

Lastly, for those who do not believe in technicals, I can show fundamental support of this prediction. Dating back to 1959, the 7 recessions that have occurred have lasted on average just over 1 year. The current recession is in its 17th month. Of the 7 recessions that have occurred since 1959, only 5 are technically recessions. Economists will generally agree that recessions are defined by two consecutive quarters of negative growth. Only 1 of the last 7 recessions had three consecutive quarters of negative growth. The current recession has had two. The economic data is showing empirical support that the economy is improving, or at the very least, that housing has bottomed. Considering the level of government spending coupled with quantitative easing and the significantly increasing money supply, once growth begins, it will explode. Although most of this growth can be attributed to inflation, it is growth nonetheless. Once the all clear signal is given, the unprecedented level of cash on the sidelines will pour into the equity markets causing a huge rally.

This is extremely bullish

SPX

SPX

The uptrend is not over! The markets are adjusting perfectly for the next move higher. In the chart, the SPX is trading in an upward trending channel. The downside resistance in the channel is SPX 820 in a worse case scenario today.  It is very likely we will close much above this as closing at 820 would be almost a 6% slide. The horizontal line on this chart illustrates former resistance becoming support. If the SPX retests 820, it will make a double bottom. Not on this chart, Fibonacci retracement levels for 3 month time frame are: 875 and the March lows of 667. It’s no coincidence the SPX retraced after touching 875, this is very healthy. If Fibonacci retracement lines are drawn on this chart, in this time frame, the next support level is at SPX 832. As a result, I am not surprised that currently we are trading at 836. I do not expect the day to get much worse. In the recent uptrend, down days have been violent and on low volume, and today is no different. There has not been more than two consecutive down days since the March lows. Although it is possible for us to be down again tomorrow, I do not expect this, unless there is a negative earnings surprise.

Unfortunately, people forget quickly and have unreasonable expectations. Many bears are coming out of the woodwork, saying “I told you the markets were due.” They proceed to suggest that now the bulls are “bottom fishing.” I find this very ironic since most of the bears have been top fishing for the last six weeks. This time, the bears who went short on Friday, got lucky. There is no real catalyst for today’s downward price pressure other than the fact that markets do not move in a straight line. It is terribly wrong to try to short this rally. Eight months ago I traded by the saying “don’t be caught wrong long.” All this simply means is that if I’m going to be wrong, I might as well be wrong short. Since I was fairly certain the economy was getting worse, this was a safer bet. Now the economy is improving, and the saying has switched. Being wrong short is a recipe for disaster. It’s clear the government will do whatever it has to for the banks to succeed. Do not try to get cute and attempt to time this perfectly. If you are uncomfortable with today’s down move, close your long positions, but do not try to short this. I will almost guarantee, all else equal, the market closes on Friday higher than it closes today.

Dow 10K

SPX

SPX

 I know the title says Dow 10K and this is a picture of the SPX, synonymous with the S&P 500, but they track each other close enough to make the point. In addition, the price weighted nature of the Dow, versus the market capitalization weighted nature of the SPX causes some problems in forecasting. Nevertheless, the market bias is higher.

Chart Interpretation:
I have use Fibonacci retracements to show target levels as well as trend lines that suggest a head and shoulder reversal patter, also known as a Kilroy Bottom. According to the retracement levels, closing above 849.32 on the SPX is bullish and suggests the index will trade higher, more specifically to its next resistance level: 962.25. In my newsletters on www.marketfallacy.com, I called the possibility of a bottom on March 10th just shortly after the intraday lows of 667 on the SPX occurred on March 6th. This link is to the March 10th newsletter http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-10-09_2009-03-11.html. In the same newsletter I also suggested it was very likely the SPX would trade at or near 815 and the DJIAat or near 7900. In the weekend edition on March 15th, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-15-09_2009-03-15.html, I called the bottom. With the SPX closing at 806.12 on March 24th, I increased my target  on the SPX to 875, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-24-09_%7C_Dont_Fight_the_Fed_2009-03-24.html. On the 2nd of April, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_4-2-09_%7C_Cramer_Calls_Bottom_2009-04-02.html, I increased my targets once again. On the 2nd, the SPX closed at 834.38 and the DJIA7978.08. Please do not misunderstand me, I by no means am patting myself on the back for these calls, I simply wanted to post reference points to support why I changed my targets.

In addition, the purpose of bringing up the forecast is to explain what I was seeing when I made these predictions. In another article I’ll explain how I predicted that the DJIA would trade in the 6000’s all the way back in August of 2008 (DJIAwas trading in the mid 11000’s). In early March, I saw the current Kilroy Bottom forming. After drawing a neckline at almost 875, I realized if the trend holds, the SPXwould have to trade above 1000. I know the chart shows a neckline at around 950, but the interpretation of the charts are subjective. On a side note, I believe that if you are truly gifted at the stock market, you should be able to take the same information, the same charts, and tell one person why they should buy, then walk into the next room and tell another person why they should sell. The difference is probability or likelihood that the current trends or information will be realized.

Most bears are calling for a significant retracement. Some bulls are even secretly hoping for a slight pullback in fear that the markets cannot sustain the current up-trend. Let me first begin by saying, I was one of the more bearish traders in the Fall of 2008. Until recently, I thought I was watching the collapse of the greatest empire ever, the United States. However, the last month has given me much hope. America is the land of opportunity, and the current market environment is a huge opportunity. Because of these opportunities Americans have always overcome adversity, whether it’s the bombing of Pearl Harbor, September 11, 2001 World Trade terrorist attack, natural disasters such as fires in California or Hurricanes hitting the coasts of Texas and Louisiana, Americans have always shown perseverance. Unfortunately, in order for there to be good opportunities there have to be bad ones. During the past 8 months talking to different investors, I have continually reminded them that if the want the coin they have to be willing to have both sides, heads and tails. This translates to: If you want economic boom, you have to have economic recession. It’s completely natural, and in fact a very good thing. Through economic recessions, the economy gets rid of the companies that should not be, in order to prepare itself for the ensuing expansion.

I made this reference to the show that I have not always been as bullish as I am currently for two reasons. The first reason is hopefully to establish some credibility and the second, very similar to the first, is so that I could show that I change as the facts change. Until recently, there has been a lot of uncertainty in the market. Generally, markets do not like uncertainty, and as a result volatility increased. During the increased period of volatility, negative news compounded this uncertainty and exacerbated it. This resulted in psychology driving the markets rather than facts. Fear and lack of trust produced the bankruptcy at Lehman Brothers. Yes they were probably insolvent as well, but once there is a run on a bank, it almost always goes under. The bears that are left are hoping for results of the stress test or a bankruptcy announcement from General Motors to reverse this market. I seriously see these events as very positive. It’s about expectations. We all know that GM is struggling, it won’t surprise anyone if  they file for bankruptcy. I think the market might actually rally on this information as there will be less uncertainty. Additionally, results of the stress test will reveal which banks can survive andwhich will fail. Again, uncertainty will exit the markets because the bad banks will fail while the good banks have the backing of the United States Government. I know that this post is under the technical analysis tab, I’m getting to its technical relevance. But first I need to say one more thing about the banks. Some people have suggested that banks raising additional capital is bearish. While I’d agree that this without a doubt means the need more capital, obviously because they wouldn’t raise capital if they didn’t need it, but do not agree that it is bearish. The fact that Goldman Sachs was able to raise $5 billion this week without the backing of the government is huge. It means that once again people are trusting the banks to do what they do.

Now for the technical relevance of all this fundamental information. I think the markets will continue higher to approximately SPX 1000 before any significant retracement occurs. At that time I am going to reduce the size of all my long positions, but I am not going to short the market. My reference earlier to changing when the facts change will be reiterated here. Unfortunately, economists such as Nouriel Roubini are going to all the credibility they have established over the last year quickly. Nouriel Roubini, also known as Dr. Doom, is a professor of economic at Stern school of business at New York University. He predicted the real estate bubble in September of 2006, and the ensuing sub-prime crisis in September 2008. Many people viewed him as very pessimistic, just as they did to me when I told people the DJIA was headed to the mid 6000’s. Nevertheless, he received much credibility and respect for his predictions. Sadly, he thinks the economy has not bottomed, and is on the verge of losing all the credibility he gained in the last two years.

Having said this, as the SPX approaches 1000, I expect a significant retracement in the range of 20-25%. This would move the SPX back down to around 800, still approximately 20% off the March 6th lows. Remember if the SPX does get to 1000, it will have rallied approximately 50% off the bottom with virtually no down movement. Markets do not move in straight lines, although this might suggest otherwise. According to Elliot Wave Theory (EWT), we have ended the down-wave and are now in an up-wave. This change in trend is due to the violation of rule one of the three consistent rules of EWT: 1) wave 4 cannot enter wave 1’s territory 2) wave 3 is never the shortest impulse wave 3) wave 2 never exceeds the start of wave 1.

If the markets continue to follow technical analysis, a continuation of the up-trend to approximately SPX 1000 followed by a 20-25% retracement are supported by the forming of the Kilroy Bottom, Fibonacci retracements, EWT and even fundamental analysis. All of the technical analysis just covered have very similar targets, with a small margin for error. Regardless, it has been very accurate and profitable for me since suggesting the possibility of a bottom in early March.