Charting Stocks

March 4, 2007

The Bear Market Has Begun

(Update 2008: OK, so I was a bit early!)

In “The Coming Stock Market Crash of 2007,” I made the case for a major stock market decline based on both macroeconomic events and technical weakness emerging in the global financial markets. At the time, my view was against consensus as the media cheer leaded the new highs in the Dow Jones Industrial Average, dismissed the housing collapse as a “cooling,” and shrugged off the November breakdown of the US dollar. –What a difference a day makes!

On Monday, February 26th (The day before Tuesdays crash), I put out a piece titled “Brokers Break Down on Rising Volume.” I normally don’t post during the week but I felt that the move in the broker-dealer index was important. The brokers are very good leading indicators for things to come in the overall stock market. They violated their uptrend on the previous Friday and collapsed on Monday. I felt that this would be the catalyst to the coming crash.

Tuesdays sell off was fast and vicious as the Dow gave up 416 points for the day. This is exactly the type of reversal day that precedes a bear market. If you were watching the cartoon channel (aka CNBC), you heard the language typical of a bear market–”Have we bottomed?” “Is this a buying opportunity?” Rest assured that you’ll be hearing the same language for years to come as this market trends lower. –That train is never late!

The overly optimistic media neglected to report that the market breadth (# of up stocks vs. # of down stocks in the S&P stock only index) was 99% negative. In other words, out of the 500 stocks in the S&P 500, 498 were down and only 2 were up. This is something that has not happened since at least 1926!

On my January 7th post title “Stock Market Showing Major Weakness,” I pointed out the unusually low VIX, or volatility index , and the reason I thought things were about to change.

Below is a chart of the VIX at that time (As of Jan 7, 2007)

Now take a look at the volatility index today.(Below). It almost doubled in a week! Volatility tends to spike at market tops and it generally moves in the opposite direction of stock prices. A more volatile market brings uncertainty and selling.

Now let’s look at the Dow Jones Industrial Average, the index comprised of blue-chip, “safe” companies. We see a harsh reversal in the previous uptrend, momentum rolling over, high selling volume, and RSI has dipped well into “The Red Zone,” which is bearish.

The next two charts illustrate two stocks which show extra cause for concern within the Dow.

First, we see Exxon Mobile which experienced extremely high selling volume as it plunged through support.

Microsoft also breaks below support, though not on as heavy volume as exxon, MACD and RSI indicators point to further weakness ahead.

There was one place to hide last week–Inverse ETF’s!
One of my biggest concerns about the coming bear market is that there has never been such potential selling pressure in recent history. The days of “long-only” mutual funds have been replaced by less constrained hedge funds, who can, and do take short positions and can put extreme downward pressure on prices. Couple that with the new wave of “Short ETF’s,” where individuals can short the market simply by buying and inverse fund, and you’ve a recipe for disaster.

The following ETF’s experienced a record week, and were the top performers amidst the global selloff.

PSQ, which shorts the Q’s.

DOG, which shorts the DJIA

Regardless of what the media says, WE HAVE ENTERED A BEAR MARKET. Sure, the market is oversold and is likely to bounce back. Volatility should continue up and we’ll see a few triple point daily moves in either direction for the DJIA. In the near future, you’ll see “guru’s” calling the bottom and urging you to get back in because the market is cheap and this pullback is “healthy,” and a “buying opportunity.” I assure you that it is anything but. This bear market will wipe out a lot of wealth, people will lose their jobs, homes, and life savings.

In conclusion, I’ll leave you with a quote which was published in the New York Times on October 30th, 1929 (The day after the great crash and at the start of the depression).

“Many of us have long felt great concern because of the inflated condition of the stock market during the past several months…The present decline in the stock market in this country has carried prices, in many instances, to levels ridiculously low with the result that nearly all of the standard railroad stocks are cheap, and the industrial list is filled with stocks selling at real bargain prices.” –John J. Raskob, Industrial & Political Guru.

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