Ian Woodward's Investing Blog

Who’s Afraid of the Big Bad Wolf


Whose Afraid 

One could not help but feel the angst and hand wringing this past week when Hedge Fund and Carry Trade news hit the wires.  This was a severe body blow to the Bulls who hardly expected this news after the excitement of relatively good Earnings Reports a couple of weeks earlier.  As would naturally be expected, the shorts in their multifarious forms knew a good thing and took the Market down to test the usual first line of defense, the 50-dma and then in quick succession headed for the 200-dma when the former could not hold.  I’m not telling you anything you didn’t know by now that a well trained Technical Analyst would do to draw automatic lines in the sand.

Many are in a State of Denial from the shock of seeing their fortunes pruned, but we had two weeks warning with the Eureka and Hindenburg Omen triggering together as far back as June 13th, which was the very first warning sign.  (I describe the Eureka, Kahuna and Tsunami indicators lower down in this Blog.) As we well know we needed several additional Hindy’s to trigger and we got them at least eight more times until the last one on 7/24/2007. 

The bottom line is that readers of our newsletter knew well in advance that the end of this 4+ + Year Bull Run was reaching a climax.  In the March Seminar I suggested the top for the S&P 500 was 1557 and we hit 1555.90, so benchmarking and target setting does work.  With the help of the newly developed Blog I was able to keep you abreast of the thinking going into the correction.

But, that was last month, and the next question is what happened these last two weeks?

1. The Big Bad Wolf has huffed and puffed and blew down the straw house. That got us down in quick succession to a low of 1427.67 on 8/6/2007, breaking the 200-dma. and -8.2%.  As we well know 77% of the time the S&P 500 will hold at this point and either go up on its way back to the old high and beyond or it will toddle on down to test this same low. You will recall this was the first murmur of the sub-prime fiasco surfacing with vigor.

2. We didn’t have but four days to wait on the dead cat bounce to find we were headed down again, this time with Hedge Fund chaos to finish with a full break of the 200-dma to make an imprint low of 1370.60 or 12% down from the high.  The close was at 1411.27 which was 9.3% down.  So either way the gurus of the 10% folklore should be satisfied that at least the spirit of the correction has been met.  Net-net, the Big Bad Wolf huffed and puffed again and blew the second house down of Sticks. 

3. As we chewed on our finger nails on Friday morning, safely sitting in our house of brick but realizing that both Asian and European markets were being hit heavily, and the futures showing we were in for another heavy day, in struts the Grand Old Duke of York…a.k.a. Ben Bernanke and with one stroke of the pen turned blood red into green. 

4. Shorts ran scurrying to cover and of course there was some bottom fishing, but as my colleague, Ron Brown suggest in his weekly free movie, the volume was not all that extraordinary given that it was options expiration as well.  With mumble billion shares shorted, of course there was short covering in sync with the overall market coming back almost 300 points in the last hour on Thursday and for good measure another 200 points on the DOW on Friday. The net result was the S&P500 marched up to the top of the hill and finished at 1446, just a smidgeon below the 200-dma at 1449, which of course is resistance.

Next week is a new one and the $64 question is what do we expect next?

1. Given we found a new low on Thursday, that will be the temporary Base Low until further notice, so make a note of it at 1371.  Don’t forget to tap it in lightly, as we are not there yet.

2.  Your earliest clue to the Asian reaction to the Fed’s action will be on Sunday night before you trot off to bed.  Then look at what has transpired in worldwide markets before the open in addition to reviewing the Futures markets.   

3. For starters, the S&P500 must break up through the 200-dma with conviction, in other words we need to see a follow through of taking the shorts to the cleaners, but more importantly fresh buying across several Industry Groups to see some breadth of recovery.  

4. With 1080 New Lows, a veritable print to note as one of the all time lows, we still have more new lows than new highs on the day with 171 and 46, respectively.  We need to start to see those numbers reverse quickly next week, and if they don’t then for sure expect more on the downside.  So that is one item to keep your beady eyes on.

5. For any form of reasonable bounce we should expect it to at least get back to the 50-dma which is at 1485, another 40 points up (say).  Anything short of that will be a disappointment and indicative that naysayer’s who feel the Fed should have done a full basis point or better yet should cut the Interest Rate have the upper hand.  If it makes this level, then one should expect another attempt by the Big Bad Wolf to test the previous low and this time it had better be the Piggy’s Brick House.  It must hold at or near 1370 for a double bottom to feel comfortable that the ship is righted and the Grand Old Duke of York didn’t ride his 10,000 men to the top of the hill to only ride them down again.

The bottom line is expect a Double Bottom and that is the time to either sharpen your pencils to select good candidates for a new bull rally or button down the hatches for a lot longer. Otherwise gamble in Micro-Moments every day.

The Lesson Learned: If you think it’s a bottom, you are probably early, if you know it’s a bottom you are way too late.  All short covering so far.  Overseas money coming in is a good sign. 

Copyright © 2007-2010 Ian Woodward
Disclaimer: Commentaries on this Blog are not to be construed as recommendations to buy or sell the market and/or specific securites. The consumer of the information is responsible for their own investment decisions.