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The Week Ahead: Another Ride on the Rollercoaster? Add to ...

Traders in the past have complained about the lack of price movement in the summer, as it means that there are fewer decent price swings to trade, therefore fewer opportunities. This had started to change over the past few years…but should never be heard after last week’s action.

There were so many factors that buffeted the market, in addition to the downgrade by S&P and the FOMC announcement, that it was tough even for seasoned professionals to keep up.

CHART 1 HERE

This chart is not my electrocardiogram, but a 5-minute chart of the trading activity in the September Emini S&P futures last week. For those who are not familiar with this futures contract, each point move is equal to $50, so a 40-point move is worth $2,000 on margin of roughly $3,500.

I share this just to illustrate that there were several times last week where if you bought or sold at the wrong time, you could have lost as much as your margin before the day was over.

The most dramatic swing was in reaction to the Fed’s announcements. Futures rallied initially on the prospects of lower rates until 2013, but then plunged below 1,100 when they realized the Fed’s pessimistic view of the economy. Of course, futures quickly recovered, and closed the day sharply higher.

The stock market’s sharp drop over the past few weeks seems due to the opinion of many that that the U.S. economy will get even weaker, and that another recession is now more likely.

If this view is correct, stocks are likely to decline below last week’s lows by a significant amount. If not, it is my opinion that the worst of the selling may be over.

Such a steep decline in just a few weeks is more characteristic of panic sell-off, such as what we saw in 1987, than the some of the sharp drops that were observed in past bear markets.

If we are heading into another recession, there are no signs yet from the Leading Economic Indicators, which has had a very good record of signaling past recessions six months in advance.

The economic numbers last week were mixed, and this week there are quite a few economic reports. These reports may give us some additional information on the state of the economy:

Monday: Empire State Manufacturing Survey and Housing Market Index

Tuesday: Housing Starts and Industrial Production

Wednesday: Producer Price Index

Thursday: Consumer Price Index, Jobless Claims, and the Philadelphia Fed Survey

WHAT TO WATCH

The verdict on the stock market is still out, and the market is likely to take a rest this week unless the news from the Eurozone debt crisis gets worse. Since meetings are scheduled next week, and several countries have now prohibited naked short selling, this is somewhat less likely.

Clearly we have a very split market, as those averages that have a large percentage of financial stocks (like the S&P 500) look the weakest, while those with very few (like the Nasdaq-100) look the best.

By many measures, the market is as oversold as it was in October 2008… and even though stocks still went lower, many sectors bottomed at the end of 2008.

Of the major averages, only the small cap Russell 2000 has convincingly broken its 38.2 per cent support from the bear-market lows in 2009. If the 38.2 per cent level is broken, it is likely that the market will drop to the 50 per cent support levels.

A broad trading range is likely, as those bearish on the market are looking for a rally to the 1,200 to 1,220 area on the S&P 500 or $120.50 to $122 on the Spyder Trust (SPY) to establish short positions.

Even if the worst of the selling is behind us, I would still expect some backing and filling, with one (if not more) drops back to last week’s lows likely before a sustainable rally is possible. It the A/D lines start to drop faster than prices, it will suggest another sharp decline is likely.

CHART 2 HERE

S&P 500

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