Editor's note: this column was originally published on Capital Essence's CEM News on March 03, 2008. It's being republished as a bonus for the loyal readers. For more information about subscribing to CEM News, please click here.
Good Morning. This is Capital Essence's "Market Outlook" (the technical analysis of financial markets) for Monday March 03, 2008.
Stocks tumbled Friday, in the second worst day of 2008, after AIG's, a Dow component, record loss added to worries about the financial sector and more weak economic news intensified recession fears. February ended on a down note after steep losses in Friday's trading that saw each of the major indices finished more than 2% lower.
Financial stocks saw additional pressure as municipal bonds are being liquidated by hedge funds as managers are being forced to meet margin calls. The KBW bank index dropped 3.46% for the day.
Chart 1.1 - KBW bank index (daily).
Prices follow-through to the downside and hence confirmed the validity of the "retest of January low" scenario that we've offered in the previous Market Outlook when we wrote that: "the bearish MACD indicator crossover seems to favor the bear case …there is a high probability for a test of key price level at the area of January low…keep a close eye on the short-term support at February low, about 84. If this goes, we believe that January low would be gone as well." Right now, the most obvious level to watch is the January low, about 74.80. The index has a short-term resistant around the 88 level. At this juncture, only a sustain advance above this level can wreck the bearish outlook.
Again, as goes the bank so goes the tape. Nervousness surrounding the financials stocks pushed the S&P lower. The broader market index fell 2.71%% to close near its worst level of the session.
Chart 1.2 - Standard & Poors 500 Index (daily).
A couple days ago, we've pointed out that: "price rallied directly into resistant at the area of the 50-day moving average. Not only that this is a tough resistant to overcome, the short-term RSI indicator also entered the overbought territory, so there is a pretty good chance that we'll see some sorts of profit taking in the upcoming days." Prices dropped for three consecutive sessions immediately after our bearish comment.
Technically speaking, Friday massive sell-off is indicative that the counter trend rebound that started from February 7 low at 1316.75 had came to completion. At the moment we'll have to keep a close eye on February low. If this level goes, we believe that January low could go as well. Resistance is at the area of 50-day moving average, about 1400.
On a day like this, it wasn't surprised to see fears picked up. Strikingly, the Chicago Board Options Exchange Volatility Index, or the VIX, jumped about 12% to close at 26.54. For starters, the volatility index is constructed using the implied volatilities of a wide range of S&P 500 index options. It represents the market's expectation of volatility over the next 30 day period. General speaking, VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.
Chart 1.3 - Chicago Board Options Exchange Volatility Index (daily).
Looking at the daily graph of the S&P, we can see that price broke out above the one-month bearish trend-line resistant. The action is bullish and hence increases the probability for a test of January high. Support is about 21.64.
The Dow stumble more than 300 points Friday amid bad news surrounding AIG. The blue-chips index lost 2.51% to finish at 12266.
Chart 1.4 – Dow Jones Industrial Average (daily).
There is no need to sugar coating it, Friday trading action is bearish and suggesting that February low will be retested. At this moment it's unknown whether this level can be taken out or not though a failure to hold above this level will increase the probability that the market would be in a third down leg of the bear market. Short-term support is about 12069. Keep an eye on this level for if this goes, January low would be gone as well. Resistant is at the area of 50-day moving average, about 12750.
In summary: Friday massive sell-off is indicative that market participants were too nervous to holding onto almost anything going into the weekend. The action is also known as "panic selling." Panic or capitulation selling can be very scary – almost every market crash is a result of panic selling. However, since the main catalyst behind panic selling is that investors are selling in reaction to pure emotion and fear, rather than evaluating fundamentals. So, it's belief that there after panic or capitulation selling, there are great bargains to be had. Because people who wanted to get out of a stock, for any reason (including forced selling due to margin calls), had already sold. Prices should then, theoretically, reverse or bounce off the low. In other words, capitulation is the sign of a market bottom.
With all that said, last week breakdown is merely a result of continued volatility rather than a true shift in market tone. Right now, follow-through is the key. If the market had truly put in a bottom as we believe it has, then instead of losing ground (again), the market will consolidate around the area of January closing low. On the other hand, if prices, however, continue to edge lower and volume starts to pick up, then we'll know that there are still quite a number of sellers out there and the recent bearish breakdown is a beginning of another major bear leg.
Until next time, good luck.
(By: Michelle Mai for Capital Essence)
(By: Michelle Mai for Capital Essence)
Note: Michelle Mai writes technical analysis for Capital Essence and is the editor of Capital Essence's "Market Outlook" newsletter. To receive the daily edition, please subscribe. It's now available at a monthly rate.
