Chart Guy Say a Retest Is Imminent for Stocks
It's August. It's -- what? -- 95 degrees? There's already a lot of hot air blowing around out there.
So this week, rather than wallow in complex macroeconomic explanations for the stock market's actions, we're going to the charts and their masters, the technical analysts.
Chartists, unlike fundamental stock strategists, don't give a flying fig about p/e ratios, earnings, revenue growth or rumors of, say, bankruptcy filings.
Instead, technical analysts study the trading and price history for particular stocks, sectors or indexes and try to pick out patterns. Certain patterns occur over and over as a stock rises or falls (chartists have all sorts of funny names for them, like "bump and run," "rising wedge" and "cup with handle,") and they watch for these patterns in order to predict what will happen next in the market.
It's not all that complicated, but there's a certain comfort in clarity. And that might explain why chartists, despite an approach that scoffers deem as so much hocus-pocus, remain popular among investors.
While technicians and the fundamentalists use wildly different approaches, it turns out they're feeling the same way: grim, at least for the time being. Technicians say their charts indicate another big dip in the stock market is coming, and soon.
In the last three weeks, the S&P 500 index rose 8.9%, while the Dow industrials climbed 6.2% and the Nasdaq composite jumped 7.8%, but chartists say it was something of a head-fake, typical in bear-market bottoms.
While it's natural that chartists who look for the same thing find the same patterns -- after all, a line is a line and there's not fundamental gray area to debate -- there is some disagreement about what shape the retesting might take. Some question whether July was the final low, and others quibble over whether the selloff will be an easy, gentle descent or something more abrupt.
Art Huprich, technical analyst for Raymond James, looked at more than 50 years of market history and saw a very decisive trend he thinks will be repeated.
"Going back to 1949, most bear markets ended following a series of events -- a 'low, rally, retest' sequence that occurred over a period of time," Mr. Huprich says. "With the exception of one, every bottom needed that."
Currently, the market's still in a bottoming process, Mr. Huprich says, and it hit what he considers a low on July 24. Lows typically have huge volume and high volatility. On that day, the NYSE set a record for trading volume and the CBOE market volatility index surged to 56.74, very near where it was at the market's lows set in September. Any number above 40 is considered to indicate lots of shaky knees on Wall Street.
The Dow industrial average hit an intraday low of 7489.53 on July 24; the S&P 500 fell to 775.68 at one point that day.
"We saw a low, which is a function of price. A bottom is a function of price and time. We've set a low, we're in the rally mode, and what I would like to happen over the next month, month and a half is that the market come on back down to around 8,000," Mr. Huprich says.
That's about a 9% retracement.
So why, praytell, are these double bottoms necessary anyway? Why do we need two lows, instead of just one?
"When you have people who have bought on the way down, some of those will sell when it starts to rally back to limit losses," says Price Headley, president of BigTrends.com. "It feels like a gift to some of those people, and that's why the first rally is sold into. When it gets back close to their break-even level, they'll sell and be relieved."
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Mr. Headle believes the current rally will hold for a bit -- as long as the Nasdaq holds above its 20-day moving average of 1300. "The market can make some more upside progress in the short term -- probably another month or so of rally and then a potential retest of 3% or so on either side" of the old low.
However, the tenor of a possible market decline should be quite a bit different from the blow-your-hair-back drop in July. Technical analysts say retests typically have lighter volume and are more controlled, and normally a retest sends major indexes near where they were, but not below.
According to Andrew Burkly, technical analyst for Brown Brothers Harriman, the second low won't be as "intense" as the first low, in many different aspects.
For instance, the percentage of NYSE stocks trading above the 10-week moving average during July's low point tumbled to a scant 3%; in bull markets that number is around 70%. Right now, it's at 40%, and it shouldn't get that bad again. The number of stocks dropping to new 52-week lows shouldn't be as big the second time around either, he says.
Intensity also takes into account volatility. Mr. Burkly also looks at advancers versus decliners, and the ratio of NYSE volume to Nasdaq volume. Typically, when hitting a new market low, Big Board trading picks up to match that of the Nasdaq, which is normally heavier. During late July, there were a string of days where NYSE volume outweighed Nasdaq volume. The second bottom will likely have lighter volume.
And most likely, major indexes won't fall quite as far (thank goodness).
"You get within a couple of percent, but since 1949, we only found one instance where [the second low] broke through," Mr. Burkly says.
Opinions about how long we'll get to enjoy a relatively calm market until the retest vary. Mr. Burkly says retests normally come in six weeks or less. Mr. Huprich says that in bear markets he studied, the shortest time period to reach a retest of lows was about a month, and the longest was five.
Whatever the time frame, technicians caution investors not to expect any miraculous leapfrog over the second low.
"Most bottoms are processes, they're not events," says John Roque, a technical analyst at Arnhold & S. Bleichroeder. "They take time to form.
"I believe the bottom will involve a long rebuilding process. If [July 24] was indeed a low, I think we'll revisit it. Most bottoms are not V-bottom varieties, and given the amount of damage we sustained, it's likely that more repair is necessary." |
