Correction
Time – It’s Finally Arrived
Back in May I wrote a post called 'Seasonality and the Stock Market'
http://kiwiblackers.blogspot.co.nz/2014/05/seasonality-and-stock-market.html
which explained that statistically, stock markets are weakest during the May to September timeframe. I also discussed that although the markets were still rising, they were losing momentum and that because the rally had gone on for so long without a major correction, there was a good chance of one developing over the next few months.
The US equity markets rallied for another couple of months until succumbing to a short, sharp correction in July. Whilst this made investors nervous, the 4% correction was nowhere near enough to bleed off excessive investor optimism, and they returned to the markets driving them to new all time highs in September. However throughout this period the internal dynamics of the markets had continued to deteriorate, with fewer and fewer stocks participating in the rally, and many technical indicators flashing warning signs. The markets may have been at all time highs, but they were on very thin ice.
Whilst the equity markets have powered ahead, a number of storm clouds have gathered. In Europe, the same old problems are rearing their head with many of the economies in recession and the entire eurozone in danger of falling into outright deflation due to the ineffectual financial management of the European Central Bank (ECB). This fear of deflation is leading to speculation that the ECB will have no choice but to launch a massive wave of quantitative easing (QE) to attempt to boost the eurozone out of a deflationary slump, a move that up to this point in the GFC the ECB has refused to make. This combination of a faltering eurozone economy and the risk of ECB money printing has exacerbated the flow out of euros and into US dollars, helping to drive the dollar to it's longest consecutive week rally in history.
Global unrest is continuing to grow, with separatist or democracy movements rising in the UK, Spain, South America, Syria, Hong Kong and other parts of Asia. As well as the ongoing conflicts in Ukraine, the Middle East and of course the battle against the Islamic State. More of these conflicts will flare up and intensify as the global economic situation worsens.
Lastly, the fear is rising as Ebola continues its deadly creep across the globe. This is playing out in a predictable manner with initial apathy replaced by concern, concern replaced by fear, and finally once the horse has bolted, fear replaced by panic. How bad Ebola proves to be only time will tell, but my insticts are telling me it is going to get a whole lot worse before it gets better.
According to the financial media, this toxic brew of bad news was the reason for the current stock market correction. But as we know from previous posts, it is never the news that causes the move, it's the condition of the market. When the market is strong, bad news is constantly shrugged aside and discounted and the market continues to rally, or 'climbs a wall of worry' as it is known. However when the market is exhausted and ready to correct, almost any news will be interpreted as bearish and the market will fall simply because it is time for a correction.
Having reached those new highs in September the US equity markets have fallen over the last few weeks, with volatility increasing and volume growing as sellers start to overwhelm buyers.
Let's have a look at a chart of the S&P 500 Index to see where support might lie.
It is clear to see the fall of the last three weeks, and the increasing volume reinforcing the significance of the move (denoted by the three expanding red bars at the bottom of the chart). If we take the arbitrary 10% correction figure from the high of 2019 we get very close to the 1814 level that acted as support back in April. This area should the first real level of support, should this give way, we could see a short, sharp drop down to the 1737 level which would signify a 14% correction from the high. There is of course the 1904 level which is as yet unbreached, however I think the chances of this holding for any length of time are not good.
I have spoken before about Point and Figure charts and their capability to give price forecasts, so let's see if it corroborates the chart above.
We can see that according to this chart when the 1930 support level was broken, a downside count of 1840 was activated, meaning that the index should fall to this level and possibly further. We can also see the blue line of support currently at 1820. At this point I must stress that counts are not always reached but they are a useful tool when it comes to trading or investing.
Whilst I believe we have further to fall, I do not believe this is the major top that we know will come, the pieces are simply not yet in place. This is just an overdue correction before we take off to new highs and as such, it provides a buying opportunity.
