The S&P 500 broke down below its August lows on Monday. That was something a lot of folks were not expecting to happen (including some in my own office). As such, it begs the question of how far the market may yet go, especially with all the talk now about how it’s officially reached bear market status based on a 20% decline from the most recent highs. This also ties in with the dollar given the negative correlation between the two markets. So with that in mind, let’s take a look at a couple of potential indications of what may yet be to come.
First we have the weekly S&P 500 chart. It could be said that the consolidation we saw following the August lows which saw the index move around in about a 1120-1120 primary range was the building of a bear flag pattern. If we go along with that then Monday saw the expected trend continuation on the new lows, meaning we should be able to derive a basic target based on the height of the flag poll. The first red box on the chart encompasses the poll. The second one plots that area from Thursday’s peak to provide a conservative projection of about 970 for the index.
It’s worth noting that the 2010 market low is not far away from where the flag projection comes in. That gives us a pretty good expectation for support to develop in the general zone around about 1000.
For me the important leading indicator is the German DAX, which has already taken out its 2010 lows. The sovereign crisis over there is obviously a major motivator in the selling seen thus far. It’s been interesting to observe, however, that the DAX has not made new lows in line with those of the S&P 500 in most recent trading. The German market successfully tested support just below 5100 a couple weeks ago and hasn’t re-challenged that level on the latest downturn yet.
Significant in chart the above is the volume pattern of late. Notice how the volume has not been as strong on the down days as much as was the case earlier in the move. At the same time, there’s been some uptick in volume on the positive days. If that pattern holds and we see the DAX form a bottom here it would be a very good development for the global markets, and likely a negative for the dollar.
Note in the daily EUR/USD chart how the DAX actually led the euro lower by starting to break down late in August. Could it also be leading by potentially putting in a bottom?
The DAX bottom obviously works against the S&P reaching the bear flag target, but I’m not sweating that. My suspicion from looking at the monthly chart is that the market is due for a bounce in that timeframe, one which could rally the index back into the 1200s. Beyond that though would be a challenge based on the current situation. The sell-off from the year’s highs has been very aggressive, which bespeaks a weak market.
I think the best case scenario for stocks is a consolidation centered on about the 1200 level as we see the volatility come down, narrowing the monthly Bollinger Bands in preparation for the next meaningful trend move. That’s looking well down the line, though. In the nearer term, watch to see if the DAX holds its bottom. If it does, stocks will probably post a decent rally, putting the dollar under pressure as the “risk-off” trade is unwound.
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