Sunday, June 27, 2010

Are We In the Summer of 2007?

I was looking at some longer term charts of the markets recently and looked back at the topping formation the SPX saw back in 2007. When I looked closer at the action in the first 6-9 months of the year of 07 I noticed how eerily similar the patterns looked to our current market action which seems to be on thin ice. So I compared the time periods further and was amazed at how identical the top traded 3 years ago versus how the current toppy market is shaping up for the 2nd half of 2010. I believe the markets are telling us something and we should probably listen up because we all know what these topping patterns resulted in back in 2007. Will history repeat itself this year and point towards a double dip recession and prolonged bear market? You be the judge.

The first chart is from 2007 and shows the March 2007 correction was almost exactly the same in size and duration 13 days as the January 2010 correction in the SPX, which is shown in the second chart. The recovery bounce off this correction in 2007 was a melt up straight higher, the same way our Feb-April melt up played out. Both of these rallies lasted just under 3 months in time and extended at least 161.8% higher beyond the correction to make new highs.

The larger correction the SPX saw in July-Aug 07 displays similarities of the selloff we just saw in the month of May 2010. Both of these corrections retraced about 100% of the previous run up but DID NOT violate the previous lows, instead making a double bottom. Also, during these times when the market was at these lows the sentiment in the marketplace was extreme fear such that it was a given that the market would crack and see new lows. The summer 07 correction was 12% while our recent May 2010 selloff was 14%. The other incredible stat is that both corrections lasted EXACTLY 20 days from high to low.

This correction also saw the break of the 200 day ema and lots of folks got bearish when that level broke back in 2007. Of course it was the right move long term but short term it provided for a bear trap in which the shorts got squeezed as the market rebounded into the fall of 2007 and eventually made new highs at 1576 before rolling back over and starting the bear market in early 08. This is the same feeling and behavior the current market is showing as the correction in May saw a break of the 200 day ema and it has stabilized enough to bounce back but has remained volatile.

You see from the summer of 2007 it took a little bit of time backing and filling before we saw the rally to new highs. This is kind of what we are seeing right now in the market as the SPX bounced back to 1130 and then sold off to 1070. Since we made price lows we have traded above those lows for about 22 trading days. The rally in later summer 07 lasted 39 trading days off the low in August and eventual high in October. So if you are a believer in history repeating itself then we could grind up for another 17 days or so before a similar fate for the stock market could be dealt, that being an important high being reached. That timing could come in around mid July.

After that time period if the market does not show considerable strength and bullish price action then it could be in for the start of another bear market going into the fall of 2010. In the third chart you can see where the market went after the summer of 07 and the highlighted portion shows where our current market could be going in the next 12 months.

Fundamentally speaking, the markets topping action in 2007 was as a result of fear of the unwinding of the credit crisis and eventual defaulting of debt by several large banks. The current fear of 2010 in the market is over the unwinding of the sovereign debt crisis in Europe and potential global contagion that sees entire countries defaulting on their debt. It's a very similar and real fear.

The similarities of the SPX in 2007 and 2010 are amazingly glaring so whatever you believe is headed our way you cannot ignore the price action as it is the most unbiased indicator of all aggregate supply and demand in the markets between participants.

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