Forecasts For Market Go Lower And Lower
BY DAVID SAITO-CHUNG
INVESTOR'S BUSINESS DAILY
General News
Friday, July 12, 2002
The S&P 500 at 500? How about the Dow Jones industrials falling to 5543?
At brokerage giants Merrill Lynch and Salomon Smith Barney, technical analysts — who champion trend lines, support levels and chart-based signals of market tops and bottoms — think those levels are possible.
Such doomsday warnings, however, usually are a good sign for the market. At extreme turning points, everyone is proved wrong.
"You have to believe charts about 51% of the time," said Don Hays, head of HaysAdvisory.com and a veteran market strategist. "It's sort of like the market has this major wisdom. At the bottom it does something to make the fundamentalists, the technicians and everybody wrong."
Targets Lowered
True, many market pundits dismiss the value of technical analysis. But the past few weeks of deep decline have thrown Wall Street's predictions into the spotlight.
On Thursday, Merrill Lynch's chief global technical analyst Tom Hobson's team wrote in a research note to clients that if the Dow industrial average breached its September 2001 low of 8062, the next key level to watch for in the current quarter would be 7914. On Thursday, the Dow dipped as low as 8605 but ended off just 0.1% at 8801.
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Chart: How low can they go?
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If the blue chip index falls through the 7914 level, market analyst Richard McCabe's team wrote, then look for 7628 and 5543 as potential targets.
Calls to Merrill Lynch to ask how he came up with such numbers weren't returned. In any case, the target of 5543 implies the Dow could fall as much as 53% below its January 2000 high of 11,750.
The S&P 500, which already undercut its Sept. 21 low last week, on Wednesday took out its October 1998 low of 923. To the market technicians at Salomon Smith Barney, this fits the pattern of a three-year, head-and-shoulders top.
Head And Shoulders?
If you draw a horizontal line at 950 to connect them, the September 1998 and 2001 lows form the left and right shoulders. The tech-led run-up in 1999 and early 2000 creates a massive head. The past few weeks of declines complete the formation, with the right shoulder extending to new lows.
"Our initial target is 800, and a measured move from the neckline carries the S&P 500 a bit lower to about the 500 level," Salomon wrote in a July 3 "Technical Research" report to clients.
Salomon also noted that an uptrend line starting at the market's lows in 1990 and 1994 intersects the S&P's neckline at 950, marking the end of a major advance.
"Everybody is trying to put a signpost out here so you can tell what's happening, and this happens every time you have these major declines that really are excessive from a historical standpoint," Hays said.
History shows that technical analysts' predictions are made to be proved wrong.
In an Oct. 9, 1998, article in IBD, Victor Weintraub of Phoenix-based technical analysis firm FirstCapital predicted more downside. At the time, stocks were in a sharp decline after peaking that July.
"We did not have a major decline in the blue chip averages. There wasn't panic," Weintraub was quoted as saying. "We had a lot of price volatility, but damage is still in the tech stocks and small-cap stocks.
"Certainly, this is not a capitulation. It appears the large caps still have quite a ways to go (down)."
What actually happened? The major averages rallied that day. Three sessions later on Oct. 14, the Nasdaq followed through with a 2% gain on heavier volume.
The next day, the Federal Reserve made a surprise cut in the fed funds interest rate. Investors rushed into stocks, and the last leg of the 1990s' mighty bull market was under way.
Technical analysts also were more pessimistic than the market proved to be in 1990.
When the Dow began a steep decline in August that year, Ed Nicoski, managing director of technical analysis at then-called Piper, Jaffray & Hopwood, correctly said the decline was "still in its infancy."
He pointed out that the decline broke through an uptrend line stemming back to the October 1987 crash lows. It's when the market breaks that kind of major trend that portfolio managers tend to act, he noted.
The Dow did indeed keep falling. But once it bottomed in October 1990, the market began a huge rally lasting a decade.
Besides the chart gurus' negative views, several psychological indicators also signal rising bearishness:
• The CBOE's Market Volatility Index, or the Vix, Thursday spiked above 40 for the first time since last September, when the terror attack triggered a panic sell-off in stocks.
• The put-call ratio has shot above 1.0 several times this year. That means options players traded more bearish puts than bullish calls.
• The American Association of Individual Investors' weekly investor survey on July 3 showed a bearish sentiment of 46.88%, the highest level since 1994.
In past years, such sharp bearishness has marked market bottoms.
All these signs together won't pinpoint exactly when it's safe for investors to jump back in the market. The market often needs time before it proves a new rally is under way.
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