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Wash, Rinse and Repeat

Most pundits have only recently caught on that we are in a bear market and in all likelihood, the US and global economies are in a recession. The possibility of a "soft patch" has given way to the possibility that we are in a recession. Of course, the "soft patch" concern dissipated back in July when the stock market rocketed 10% in 8 days, and now the stock market's tumble must be telling us something.

When you look at the headlines, they are screaming bear market and recession. This snapshot was taken yesterday from RealClearMarkets. See figure 1. There is little if any happy news. And as it turns out, I would agree with the overall tenor and assessment of these articles. We are in a bear market, and in all likelihood, the government agency that confirms recessions will likely do so at some point in the future. Ahh, but here is the interesting thing. Just because we are in a bear market doesn't mean the stock market cannot rally.

Figure 1. Real Clear Markets

In any case, investors must be feeling a bit beat up not because their portfolios are down but because when they are told the coast is clear or armageddon is upon us, the market does the exact opposite. I am bullish because investor sentiment is extremely bearish. My "call" isn't so much a contrarian one --i.e., go against the prevailing sentiment -- but more like these guys are a half step behind. By the time they recognize its a bear market or a recession that news has become priced in and the market starts on a counter trend rally. The whole price cycle starts over again. Its wash, rinse and repeat.

From a technical basis -- and I am not sure what that means -- price should stabilize at these levels. It is a bear market, but significant support levels are lurking nearby. This can be seen in figure 2, a weekly chart of the SP Depository Receipts (symbol: SPY). The break below the key pivot at 127.18 was the first major warning sign of a bear market as prior areas of buying should act as support in bull markets, and the failure of the next support level at 120.79 (i.e., November, 2010 and QE2 breakout) to hold served to confirm the bear market. Support, which is significant, is at 108.37.

Figure 2. SPY/ weekly
SPY Weekly

A weekly chart of the PowerShares QQQ Trust Series (symbol: QQQ) is shown in figure 3. The November, 2010 support level at 50.12 remains intact. A weekly close below this level and it is lights for the QQQ; expect another 10% drop to 44.94.

Figure 3. QQQ/ weekly
QQQ weekly

The rubber band is pulled back pretty far -- that is, investor sentiment has become extremely bearish. My expectation is that the ensuing rally (if it develops) or snap back will likely go further and farther than most expect. Of course, that will depend upon news events, short covering and if investors embrace the rally or not. Money has to be on the sidelines and short covering must be prevalent to provide fuel for any counter trend rally.


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