Over the past two weeks, US markets once again displayed a major increase in price volatility due to large write-downs at Citigroup, Wachovia, Washington Mutual, and Merrill Lynch and lay-offs in the mortgage and investment banking businesses of Bank of America. For the short term at least, sub prime jitters re-entered the market.
To balance this negative picture was the observation of how well supported the market was toward the end of last week at its medium term support level of 1500, which can be drawn back to May this year. This was even in the face of a major write down by Countrywide, the USA’s largest lender, which on Friday posted a $1.2 billion loss in the third quarter, but predicted a return to profitability in the fourth quarter. (Side note: We have not observed such an extended sideways pattern since Nov 2001 to April 2002 basis the $SPX).
Markets never stay still and the factors which have contributed to the pattern of price behavior over the last six months (sup-prime mess) are continually being replaced with new information, which is being factored in and will dictate the next move in the overall stock market. One of the major levers that drive the markets is interest rates. As we are well aware, on the 18th of Sept the US Federal Reserve cut US interest rates by 50 basis points, which had a dramatic supportive effect on the markets and temporarily soothed sub-prime fears.
On Wednesday the 31st of Oct, the US Federal Reserve will once again meet with the primary task of deciding whether to cut or maintain the current US interest rate. According to futures listed on the Chicago Board of Trade, traders are pricing in an 86 percent chance that the central bank will lower the fed funds rate by a quarter of a percentage point, to 4.5 percent.
Markets are clever and often do not wait for an event to happen. Normally markets start to anticipate and factor in some of the expected interest rate cut, hence you would expect to see some evidence of this being reflected in the major indices. I will use the $SPX index to illustrate.
Let’s take a close look at the purple box and see if we cannot glean any clues to what the market is potentially going to do next. It is often difficult to see the complete picture on a daily chart, so I want to illustrate the fractal nature of the market by drilling down to a 60 minute time frame. The reference to “the fractal nature of the market” refers to the fact that what works on longer time frames often can be seen to work on shorter time frames.
In previous articles I have referred to a W formation which can often be observed as a completion pattern after a correction in the markets and is that point where the market is making the transition from bear to bull (or the reverse). (This pattern is used in all Auto-Trade recommendations.) If the market is truly fractal. you would expect to see the same patterns observed on a daily chart displayed also on a 60 minute chart.
Now looking at the 60 minute chart we can clearly see the market forming a low point at A, retesting its low at point B, before trending up. The market then forms its first higher low at point C and second higher low at point D. From this point we would expect a small pull back to from a third higher low, confirming that the bulls are back in control if not already. The W formation is essentially Phase 1 of a market move from its accumulation phase. Followed by Phase two its uptrend then phase 3 distribution and then phase 4 decline.
Once again this is a probable scenario, not a guarantee that the market will trend up from this point. That said, there is a body of price evidence on the chart supporting the bullish case and reflecting the expectations of traders of a near term interest rate cut.
The purpose of the article is to demonstrate how we form a Macro view of the overall market which begins at Phase 1 the accumulation zone which is the transition zone from bear to bull. This methodology is being applied to the overall market and to each Wise Report recommendation at a stock by stock level.
Kind Regards,
Paul Wise.