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Markets are at a Key Turning Point

Friday was a key day for the financial markets. Not only did the DOW fall almost 400 points and break the back of the bear market rally that began in March, but oil, bonds, and currencies also made important moves. I don't want to say it was a pivotal day for the markets. The true pivotal time came back in October when the last bull market cycle came to an end. Friday simply signals a continuation of the primary bear trend, but it marks the end of the bear market rally that tricked most investors into thinking the bear market was over.

Almost everyone in the financial press has been claiming that the stock market put in a major bottom in March. They argued that the Federal Reserve had successfully stopped the credit crisis by printing billions of dollars to help JP Morgan buy out Bear Stearns. They then claimed that the economy had put in a bottom. As the market rallied up more and more people became convinced of these things. Now the bank stock index is already on its March lows while the economy faces a huge threat from the inflationary impact of the effects Fed printing has had on the dollar. Instead of a magic fix, the Fed's actions have made a mess at that gas pump.

It is an old adage that the markets are driven by fear and greed, but bear markets are really driven by pure fear. People are most afraid of not losing money, but of missing out on the next bull market. When bear markets have short-term rallies they hold on in the fear that the rally marks the beginning of a new bull market. They refuse to sell, because subconsciously they don't want to miss out. If they are professional investors they are fearful that if they sell and the markets go up without them their clients will take their money away while if they are just a regular investor they are scared that if they sell they'll feel stupid as their neighbors hold on and make money and everyone on CNBC celebrates.

What people do is hold on due to these fears. In their subconscious mind they rather by wrong along with everyone else than possibly be wrong all alone. They then rationalize holding on by convincing themselves that the bulls are right - that a second half economic recovery is going to happen, that real estate has bottomed, that the election will help - they grab on to any argument and turn their eyes away from the realities of a tapped out consumer, high oil prices, and real estate prices that won't bottom out until at least late 2009.

These people then end up selling near the bottom in pure panic when the market forces them to sell. We've already seen three bouts of selling panic in the past year. They came last August, January, and March and now the market is setting itself up for another one.

This is bear market action folks and the bear probably won't go away until next year. To make money you have to separate yourself from the crowd by using technical analysis to spot turning points in the market to take positions against it and by sticking to only a few sectors that are still in bull markets for longs and right now that means commodities and gold and silver stocks in particular.

1370 has acted as key support for the S&P 500 since the middle of April. By closing below 1370 on Friday the S&P 500 broke down. The next support level is at 1350 and then 1327, the 50% and 1/3 retracement levels of the March low and April high. We may see the market pause at one of these levels as it goes lower, but I don't expect to see much of a rally happen from them. Ultimately, the S&P 500 is going to the 1280-1300 area. It will probably then rally for a month or so and then go lower to mark the beginning of the next real leg down of the bear market.

Notice the blue arrows I put on the above chart. Since the end of April the market has had much greater volume on down days then it has on up days. This is a classic sign of distribution and was a warning that the rally was going to fail.

It will probably take you a few moments to grasp what is going on in the above chart, but it is critical to understanding what is happening right now. Over the past year we have seen a trend in which when the market drops bonds and gold rise as money leaves US stocks and flows into safe haven instruments while at the same time the dollar drops. You may have noticed that on Friday every single stock sector was down but one - precious metals.

In the above chart I've drawn two vertical lines. FXY is an ETF that tracks the value of the Japanese yen versus the dollar. When it rises the yen is going up against the dollar. Notice that at the start of the year this ETF rallied as the S&P 500 dropped. Then in March, the point of my second vertical line FXY corrected. It is now sitting right on a downtrend resistance line connecting its recent highs and is poised to breakout. As the market decline continues you can expect to see FXY rally back up to 100 as foreign money flows out of the US dollar and stock market and goes into other currencies.

Below FXY is the TLT ETF, which tracks the US 20-year treasury bill. When the US stock market drops mutual fund managers sell stocks and buy bonds as a safe haven. It is a robotic habit for them that they do, because that is what they were taught to do in business school and is what all other fund managers do despite the fact that bonds yield less now than the rate of inflation. You can see how TLT rallied in January and corrected after the March low in the S&P 500 just like FXY did. However, it did not rally as much as FXY and has acted much weaker on its last correction. US bonds have a tendency to act as a safe haven, but this trend is starting to weaken. I expect TLT to rally along with FXY as the market drops, but at a much weaker pace. Bonds are in the process of making a secular top.

Below FXY of course is gold. Gold had a big run at the beginning of the year as the US stock market dropped and has been correcting since March. However, it is now poised to break a downtrend resistance line, which will make the trend bullish again.

In the recent corrections in the S&P 500 FXY, TLT, and gold all began rallies at the start of the correction, but once the correction reached its final days they pulled back with the rest of the market and then corrected as the S&P 500 rallied. I expect the same thing to happen over the next few months.

This article is an except from a WallStreetWindow subscription article. The full article contains more price projections of what I see happening for the S&P 500 and gold for the rest of the year. To get the complete future articles subscribe to my free weekly newsletter. Just click here.

 

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