Although the Dow, NASDAQ and S& P 500 all gained over 3% on Thursday, triggering predictions that the correction is over, I remained unconvinced. Everything I witnessed this week has only persuaded me that we are going lower.
Last week I wrote that I the S&P 500 would bounce off the 1,050 level. If it failed to do so, I advised readers to raise cash. Fortunately, the markets did bounce at that level gaining almost 4.5% in two days. However, the bounce lacked the volume and follow through I was looking for. As a result, I suspect the next test (and there will be one) of that 1,050 level will fail and the markets will drop further.
How much further will depend a great deal on what happens next in world markets.
Will the problems between the two Koreas escalate? Will the financial reform bill (once passed) be better or worse then expected? Will the economic prospects of Europe and the Euro continue to deteriorate? So many unfathomable issues and too few definitive answers expected anytime soon.
The market’s 3% rise on Thursday, according to CNBC and the Wall Street Journal, indicated that investors were once again willing to embrace greater risk. I believe those assurances are a bit premature. The sell-off on Friday, for example, was fueled by a downgrade of Spain’s sovereign debt by Fitch, the credit rating service. Fitch only dropped it’s rating from AAA to AA+ but it’s the direction that counts. Like Greece and Portugal before it, investors fear Spain, the ninth largest economy in the world, is on the brink of even worse economic problems.
Lest we forget North Korea led by Kim Jong il, that Hitler wannabe with a propensity toward world annihilation, they reminded us on Friday that risk was still very much alive on both sides of the DMZ. One of Kim’s tin soldiers, Major General Pak Rim Su, threatened an “all out war” if there were any accidental clashes on the DMZ or on the High Seas with its southern neighbor. Investors, not knowing what evil may lurk over the long Memorial Day weekend ahead, decided not to risk holding stocks.
I believe this kind of environment will be with us in the weeks ahead. Good news will be met with spurts of panic buying while bad news will generate heavy sell-offs, pushing the markets lower until there is some resolution to these overhanging problems. The S&P 500 could move somewhat higher in the short term, but probably won’t get much beyond 1,120-1,130. Use any bounce to reduce positions and raise cash. I think the S&P 500 breaks the 1,050 support area. The first stop after that could be somewhere in the high 900s. If that level doesn’t hold, you’re looking at 940-950.
If I’m right, that equates to an overall drop in the market of between 18-23%. That kind of correction is too severe to simply stand back and take your lumps. I recommend selling your most aggressive investments now and use any bounces to generate even more cash.