Wednesday, May 21, 2008

The next selloff begins

Several market sentiment indicators this week returned to the optimistic levels of the October 2007 peak, which is a strong signal that a medium-term decline is on the way. Today the S&P 500 fell 1.6%, passing below the lower trend line of the ascending wedge formation which has been in place since March; such a violation usually heralds a selloff.

Taken together, the optimistic sentiment and trend change are about as strong a signal as you will ever see of an impending decline in the market. Since the S&P 500 closed at 1565 during the previous sentiment peak, but only 1426 at this week's peak, the coming decline will probably take the S&P below the March lows of ~1275.

As before, a slow decline is still more likely than a sudden crash due to record proportions of shares waiting to be re-purchased by short sellers.


John said...

I really enjoy your perspective. Fudamentally you are always dead on. I wish the market reflected those issues. That selloff wasn't impressive. We probably still have another wave down but the possiblity of retesting 1550 before our plunge is becoming more likely. Have you seen anything technical or otherwise to suggest some weakness?

If we fail to break lower support 1386 or 1364 it'll be time to go long term bullish don't you think?

Is there a catalyst we're missing that would really create another panic sell off?


Jody said...

Thanks, John.

I think it's a bit early to declare the sell off over. In bear markets, declining phases start slowly and then accelerate. (See May-Sept. 2001 and March-July 2002.) I imagine that these sell-offs start slowly precisely because investors don't think it's going to happen at first. So far then, the market is going according to script. The S&P would have to close above 1426 (form a new high) to disprove my prediction of another downward leg.

Overall sentiment is still relatively bullish, which is bearish for the market. And of course the long-term fundamental pressures aren't going away any time soon: the S&P has only a 2% yield and a forecast P/E over 20 for the next 18 months.

I think the high degree of short interest is the largest impediment to a fast and deep sell off right now. Again, that leads me to expect a slow decline for the time being.