Thursday, March 04, 2010

The Stock Market's Textbook Change of Trend

This Week's Theme: "I've got a bad feeling about this..."

Global stock markets are rolling over in textbook change of trend.

This week's theme will be familiar to anyone who has seen the original Star Wars films in which Luke, Leia or Hans Solo utter the ominous words "I've got a bad feeling about this..." just before a crisis strikes.

I've got a bad feeling about the global equity markets; they are rolling over, presaging a potentially powerful trend down. Let's start by scraping away the happy-happy propaganda about the "global recovery" and confessing that all the central bank manipulations (zero interest rate policy, unprecedented deficit spending, the propping up of insolvent banks and the mortgage markets, manipulation of equity and bond markets, etc. etc. etc.) have created a simulacrum "recovery" which is already faltering despite governments borrowing 10%-15% of their GDPs in a desperate attempt to reinflate the asset bubbles which fed the Elites and the State so well over the past decade.

The "recovery" is a travesty of a mockery of a sham.

We all know employment is still falling, housing is still falling, commercial real estate is falling at a quickening pace, shipping and rail traffic are declining, tax revenues are plummeting, and so on. Here is one representative chart of China's manufacturing new orders--yes, China, that suposed "engine of the global recovery" is rolling over, and as I type the news is the Shanghai stock market fell 2.4%. Little wonder; there is nothing but government stimulus to keep the bubble inflated.

For more on why China's property bubble will pop, please read my AOL Daily Finance article Why China Can't Cool Its Overheated Real Estate Boom.

Chart source: Is China's Lower PMI Report the Canary in the Coal Mine? by Prieur du Plessis.

Let's use the Dow Jones Industrial Average as a proxy for global stock markets.The same patterns are visible in most major markets.

Here is a textbook example of a change in trend from up to down. I've drawn three trendlines to illustrate how the market has weakened in the past 4 months. The initial strong uptrend (red line) has been decisively broken, and this weakness was evidenced by the way the uptrend flattened (blue line).

The green line indicates that the market trend was basically flat from mid-November, a classic sign that the uptrend was weakening.

In a real Bull market, this loss of momentum is considered consolidation, as the market (in a favorite financial media cliche) "digests its gains." (Why does this bring to mind a python consuming a pig?) This consolidation sets up the next leg up.

Alternatively, this hesitation is distribution, as insiders and traders sell their shares to others who believe the uptrend is still in place. Distribution is marked by one classic sign: heavy volume on down days, light volume on up days--precisely the pattern of the past two months.

The Bulls attempted one final push in January to spark a new uptrend but this rally failed, breaking through all the Bull's trendlines.

Now another classic topping pattern is forming: a head and shoulders. After noodling around the 10,500 level for six weeks, the DJIA lurched higher in January but quickly surrendered the new uptrend, leaving a "head" around 10,750 (10,767 was the intraday high).

Now the Dow is banging up against resistance at 10,450, day after day, as the low volume rallies go nowhere (distribution). This futile flailing is forming a right shoulder.

In another classic sign of a change of trend from up to down, the 20-day moving average has slipped below the 50-day MA, and remained below it for over a month. That is not evidence of an uptrend or a flat trend; it is a textbook example of weakness.

Uptrends tend to last a long time, while downtrends tend to be explosive. Thus we can anticipate that the market will cascade down rather quickly when the world's speculators and investors wake up to the fact that global growth is a government-induced chimera, that asset bubbles are still deflating, that business as measured by tax revenues is falling, that households are poorer, that government deficit spending is unsustainable, and that the Eurozone is falling apart.

For more on why this is so, please read my AOL Daily Finance article The Greek Debt Crisis Exposes the Eurozone's Fundamental Flaws.

There is nothing fancy about the technical analysis displayed in this one chart. It is a textbook example of how trends change.

Before you get too excited, though, please re-read the HUGE GIANT BIG FAT DISCLAIMER below which explains that these are the scattered, freely offered opinions of an avowed amateur observer and are not investment advice in any way, shape or form.

OK, now that the gory details have been dispensed with, let's get back to the coming train wreck: how low will the market fall?

I have long held the opinion (often stated here) that markets tend to re-test their lows, with the 2002-2003 period offering a recent classic example. Given the absurdly threadbare nature of the "global recovery"--a glossy facade of managed perception masking a rotting structure in slow collapse--then it doesn't take much imagination to see the Dow falling rather quickly to re-test the March 2009 lows around 6,500.

And since things tend to overshoot when human emotions are in control (i.e. stock markets), I would not be surprised if the Dow were to overshoot the old low below 6,500 to the 5,800 or 5,900 level.

I would also not be too surprised if it held slightly above the old low, around 6,900.

We shall see, and soon.

NOTE: Due to work overload and obligations in the real world, my time online will be severely limited this month. My apologies for being unable to respond to all email and thank you for your readership.

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