A short-term and long-term analysis, plus a road map for the Dow from July to September.
The Dow Jones has, until recently, been closely following the roadmap for 2008 posted on March 24, 2008, as part of the Global Stock markets outlook – i.e., both the rally in early May to 13,136 and the subsequent downtrend to 11,700 by the end of June were virtually spot on. The analysis was confirmed in the analysis of May 3, 2008, which concluded that sell in May and go away would occur this year, as transpired during the subsequent decline into the end of June as the below road map chart illustrates from the March article.
However, the break below the support level of 11,500 represents a serious deviation from the anticipated trend, which had originally called for a bottom to be made by now around a price of 11,700, against the last close of 11,100 on the July 11, 2008. Whilst the absolute price is not important, what is important is the break of support, which implies weakness rather than strength for the next stock market upswing, which had envisaged a trend back up towards 13,000 by the end of September 2008. Therefore, this analysis seeks to update to the roadmap/forecast for the Dow Jones to try and gauge the likely trend for the next three to four months that would take the Dow Jones into late September.
Charts courtesy of Stockcharts.com.
Briefly – Fundamental background
Fundamentally, the situation has continued to deteriorate on the earnings front, and there is little signal of an imminent low either in the housing market or the banking sector, which on Friday saw the financial sector on the brink of collapse as Fannie Mae (NYSE: FNM, Stock Forum) and Freddie Mac (NYSE: FRE, Stock Forum) crashed by 50%.
The other major event since March has been the surge in the oil price, which has carried crude oil from $100 towards the $150 target for the year in just three months! This is probably the prime reason for the deviation in the Dow's trend and worsening of the technical picture for the stock market, which has triggered a technical bear market on a fall of 20% from the high. Therefore, the crude oil price is an important factor in determining the future trend of the Dow Jones Index.
However, as I mentioned in the recent article Crude Oil Seeking Black Swan for Spike Above $150 in Overbought State, we have the problem of a black swan event, namely an attack against Iran's nuclear facilities, that would result in a spike higher that would be accompanied by a major sell-off in the stock market. The only way around this possibility is the need to arrive at a conclusion, and in that regard my conclusion is that there will not be an attack on Iran and therefore the future trend in crude oil during the next three months will be orderly – i.e., based on technical factors rather than a black swan event.
Even so, crude oil will remain volatile due to the rumours of an attack, which will make the stock markets volatile. Unfortunately, these rumours could occur at inopportune times that may trigger sharp declines – i.e., if the stock market has fallen to support and a strong rumor occurs that spikes crude oil higher at that time, then that would trigger a break of support, which is precisely what transpired during late June. So I also have to factor in the probability of rumours into the Dow Jones road map, which, therefore, is a much harder exercise than the orderly crude oil trend observed from March to late May, which was anticipated to juncture at that point for a significant correction that never transpired.
Technical analysis of the Dow Jones and road map July to September 2008
The current breakdown below support of 11,731 is undoubtedly bearish and thus implies a weaker trend. However, the seasonal bias for an uptrend into the U.S. election still remains, as the swing pattern observed to date still matches the expected trend, its just that the timing and the magnitude of the subsequent rally is now in question.
On Friday, we witnessed how close the stock market came to a crash on the IndyMac bust and Freddie & Fannie about to burn the house down. Therefore, again, technicals may be outflanked by black swan events.
On a short-term basis the Dow Jones is oversold and the MACD is eager to give a bullish cross, this therefore implies a rally is imminent. The immediate target for this is the down-sloping trendline presently at 11,600 and then the 11,730 previous low, thus representing a healthy move of over 600 points on Friday’s close, and represents the direction of the next initial minor swing. Beyond that we need to look at the longer-term picture.
Long-term trend and road map
I cannot ignore the fact that we are now in a technical bear market; therefore, the following rally is expected to be corrective – i.e., we are, at some point, going to revisit the low seen last Friday.
The MACD is undoubtedly oversold but bearish longer term – i.e., it is confirming that we are in a bear market where the trend will be between oversold and neutral.
The Elliott Wave theory failed on the upside peak to 14,200, which was at a Wave 7. However, the subsequent trend is confirming a bear market of three waves down, of which A and B have been completed; this again suggests that the current rally will be corrective in nature, with the Dow destined to revisit and break recent lows.
A break above 12,500 would be considered bullish and imply an assault on the 13,136 high.
A break below 11,000 would imply a continuation of the bear market and start of the C wave decline.
The Dow Jones is expected to make an imminent low if it has not already done so. The expected uptrend will be volatile, but targets a move to above 12,100 by September 2008, which represents a move of +1,000 from the last close. However, this is a much harder call to make than the one in March given that we are in a bear market and so many potentialblack swan events exist, such as last Friday’s near crash on IndyMac, the Freddie Mac and Fannie Mae events, and the risk of an oil price spike following an attack on Iran that will reassert the downward bear market pressure and lead to an earlier termination of the anticipated corrective rally.
Copyright © 2005-08 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.