With half of the year 2009 already in the books let us peer into the unknowable future and see if we can see some broad outlines of what might be in store for the second half of 2009 for the broad markets.
This is basically the game of “What Happens Next.” As nobody knows what happens next, we trade our prognostications with care. We let the market confirm what we believe happens next with whatever tools we use that give us an edge (the higher probability of one outcome over another outcome). Market direction into July 17th expiration and possibly closer to the end of July should be down.
A possible head and shoulders formation is setting up and a break of 880 (approximate neckline of the formation) on the S&P would confirm the formation. However, this is very obvious and something commented on by almost every technical trader and trading service out there. That, in and of itself, is bothersome.
Here is how I see that play out. 1-2 more trading sessions of down action. Possibly taking the S&P well under 880. Then a brief oversold bounce and then down into the July 17th options expiration and possibly continuing down into the next week after expiration. Earnings season is then underway and I think there is a high probability of another rally. We have just had a bear market rally of historical proportions and rally #2 could well be of equal proportions taking the S&P to new recovery highs in the 1050ish area. We do have a large unfilled gap between 1055 and 1100 on the S&P. That gap could even get filled. Little known fact but upside gap fills are bearish.
What could fuel such a rally? The trigger could well be earnings. Lower expectations have created an environment that beating the estimates by a small margin, even though earnings are drastically below last year’s, has lead to individual stocks rallying on earnings news. Many traders completely missed the rally off the March 9th lows. They will not want to miss this rally and will be aboard early in the move. Failure to continue towards the March lows will trigger massive short covering as traders caught leaning the wrong way, due to a failed head and shoulders pattern, scramble to cover.
As the market moves above the old recovery highs above 950, retail will also start to buy. The talking heads of CNBC will trumpet the end of the bear market again as the “green shoots brigade” calls for economic recovery just around the corner. This rally could continue well into the fall. I shall be on watch for a Hindenberg Omen (an esoteric technical indicator that predicts market crashes with startling accuracy-if you do not know what it is, might want to Google it and become familiar) to exit all long positions and take a 25-50% short position. With a confirmation Omen (another Hindenberg Omen usually within 45 days of the first Omen) I would go to a 100% short position.
Why this fall? Why a down year and possibly even a catastrophically down year? Here are my reasons:
1) There is large divergence between the Nasdaq at +11.9% for the year and the DJIA at -8.05% for the year to this point. This is the second largest divergence since the founding of the Nasdaq in 1972. The previous four largest divergences, in the order of their magnitude were 2001, 1973, 1974 and 2002. Without exception, all of those years finished significantly lower;
2) Robert McHugh, the only Elliot Wave theoretician that I follow is calling for a cataclysmic major wave C wave down starting sometime this fall.
3) For further confirmation the work of LEAP 20/20 and Half Past Human are both calling for a major dislocation within similar time frames.
Where will the markets finish the year? If McHugh is to be believed, near ZERO. That I find most difficult to believe unless markets, as we know them, no longer exist. My best guestimate is would be S&P at under 500.
This is one possible scenario. I am trading this scenario, subject to confirmation in the markets using the tools that I have come to trust. I have July SPY puts..the 94′s, 92′s, 90′s and 88′s at this point. I will exit 1/2 of the positions with a move under 88. I will look to buy back the sold position with a move back up to the 90 area after taking original risk capital entirely off the table. There are 3 trades here where a small amount of capital could become very meaningful capital if this scenario comes to pass.
With trades of this type, please, risk only capital you can afford to lose as this would be a Dan Zanger type of trade. In a Ferrari 2 inches from the wall with the gas pedal flat to the floorboard.