Market Update: 2008-11-20

Well, it has been a long trip, but it looks like we have finally arrived. As I write, the S&P 500 is trading at 786. We are now officially testing the depths of the 2002 market bottom! The S&P 500 index is trading below 800 this morning, which is where it bottomed in October 2002 after the "New Economy", tech-bubble market burst during the first years of this millenium.

Early on this year I began saying that the S&P 500 index technically looked a bit scary. The chart appeared as though it was making a secular double top. As the year progressed, and the market continued to fall, it became more and more apparent that a return to the 2002 lows was completely "in the cards". And now, that "worse case" scenario has come true. No one, other than yours truly (and my Dad), thought it was even possible. I sure as heck know that Jim Cramer wasn't talking about it (please correct me if I missed that episode, not that I watch him much anyways)! It amazes me how much a simple stock chart can tell you about what may happen to stocks in the future.

Now that the S&P 500 has fallen below 800, a new question comes to mind: "What next?" This is more challenging to answer, because no one really knows. But there are really only two possible answers which I will explain next.

Possibility #1) The stock market has bottomed. Wow, finally we can relax! Under normal circumstances, I would expect that the S&P 500 would not breach its previous cyclical bear market low. The S&P 500 has major, long-term technical support at 775, and that means that it should not fall below that level for any extended period of time. Sure, it could fall below 775 for a week or so, and then as long as it quickly bounced back above that level I would not consider that a breach of support. However, the economic fundamentals that in the long run help us decide the true value of stocks are anything but normal right now.  That leads us to the other possibility.

Possibility #2) The stock market is getting ready to fall off a cliff! Assuming that the S&P 500 is not able to hold support at 775, then the coming market action will be horrible. In what I would consider a worse-case scenario, the market could lose up to 50% of its current value. Now, calm down, I am not saying that will happen! But, the reality is, if the S&P 500 falls below 775, there really isn't much support below until you get to the 400-500 level. The market would have to lose another 50% of its current value to drop to 400! All odds are that, if we do break down from here, the market will end up catching itself before falling all the way back to its early 1990s valuations. Maybe it can stop at 600 or 700. However, that still won't be any fun. But, if you have cash in the bank right now, any breach of 775 will equate to the buying opportunity of your lifetime. As I said yesterday, now that we are back to the 2002 lows, it is smart to consistently and unemotionally buy into the stock market over the next 6-12 months. Don't buy all at once, because there is a chance you will be able to buy even more shares at a cheaper price later if things get really, really nasty. The fact that the banks appear as though they are breaking down, isn't a good sign either. At this point, banks could easily lose another 25% of their current value. Given that financials make up around 16% (i.e. the biggest share) of the S&P 500 index, if the financials do lose another 25% that means that the S&P 500 will shave off another 4%. Based on yesterday's close of 807, that will take the S&P 500 to support at 775. And that is assuming that all other sectors in the S&P 500 don't fall any futher! So, could the S&P 500 break below 775? As one famous former Vice Presidential candidate would say, "You betcha!"

In summary, the next few days, weeks and months are going to be very interesting. We are living in what could be historic times for the US stock market. It is likely, but not guaranteed, that the market could have a total collapse. In the meantime, I expect that the S&P 500 will not give up 775 without a fight, so I expect more volitility in the near term and a lot of bouncing around between 775 and 900 or so. If we get another rally, it could be big, say another 20-30%. But I doubt it will hold either. Now that we are below 800, I think we will have to test this level again after any rally that does occur to ensure that we made a bottom. If we do start to break down below 775, watch out below. I would not be surprised to see panic selling with heavy moves to the downside and the odds of a stock market crash would be raised as well. Hold your breath, it is gonna be a wild ride!

We will know more about when this bear will finally hibernate later.  Until then, Happy Investing!

Gregory