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October 10, 2008

Here is the Stock Market Crash
by Michael Swanson

Here comes the crash. I've been bearish on the stock market for over a year now. I've made a lot of money this year short-selling the stock market twice. A few times I went long and got stopped out. But overall I've done well, because I recognized the reality of the bear market. That is why I'm in cash now. But I never expected a correction like this to happen. I never expected the stock market to crash.

Stock trading in Russia, Iceland, Austria, and Romania has simply stopped. Last night they shut down the exchanges in those countries, while the Japanese stock market fell 10%. Tomorrow Bush will meet with the G-8 finance ministers of the world and some hope a new bailout plan will be announced.

Bush is going to get on TV at around 10:25 AM this morning to try to make people confident, but I doubt he will be able to help. He threw fire on all of this when he said if the bailout bill doesn't pass everything will crash. He helped create a self-fulfilling prophecy. There is talk that the Treasury Department will make an announcement today saying that it will temporary insure all bank deposits no matter what their size or that Bush will say this. That is an announcement that would simply scare people even more.

Over the past week I've been comparing the action in the market to what was seen at the bottoms that came after the September 11th Bin Laden attack and at the bear market bottom of 2002.

But the comparisons most apt now are stock market crashes of 1929 and 1987 and the bear market bottom that came in the middle of the 1970's.

The stock market has been going straight down over the past week and a half - ever since Congress passed the bailout bill, which has proven to be a total disaster for the stock market.

The S&P 500 is now over 30% away from its 200-day moving average.

Today it is gapping down again. I'll be watching for signs of a bottom. There is no price level that I can say "hey this is the bottom so buy". All support is taken out and this drop is going to end when every single potential seller is out of the stock market. The hedge fund industry is over. Many mutual fund managers will lose their jobs over the next year. Brokers will lose clients. And a lot of individual investors will end up selling their 401ks and retirement accounts to never get in the stock market again. After this bottom there will be a lot less volume and trading activity in the market then there has been in the past five years, because the hedge funds will be gone.

We are in pure panic and panic ends when the last seller is gone. I'll be looking for signs of that by watching the VIX. The VIX, which measures the premium investors are paying for puts, spikes during market bottoms. If I see a positive divergence between the VIX and the market then I think we'll be at a bottom. What would this look like? The VIX would make new intraday highs while the rest of the market just sits there. I've seen this happen only three times, but every time I've seen it happen the market bottomed.

I'll be looking for something like that today, and will be updating you about the market every couple of hours in my blog, but my guess is that the bottom isn't going to come today, probably Monday. If that is right then today will likely bring another huge loss. It could bottom on the open, but at this point it seems doubtful to me. Again I will watch the action carefully. Bush is set to talk at 10:25. The market will likely try to bounce from its opening into his speech in hopes he'll say something that will help, but odds are at will sell-off afterwards. He is only scaring people.

Either way I did put together a small list of high dividend stocks I'm planning on buying. More on that in a moment. We still need to focus on the market.

Up until now the model I've had in mind is something like we saw in 2002. Back then the July 2002 market bottom came 30% away from the S&P 500's 200-day moving average. That is exactly where we are at right now. It was a huge drop that lasted several weeks and was relentless - just like this one. Once it was over the market prepared the way for a new bull market by going through a six month stabilization phase.

When this correction ends you can expect the same thing to happen -for the market to spend 4-8 months going through a consolidation phase in which it may retest the lows set here. The best time to buy stocks will be when the market is near the end of its consolidation phase - for two reasons. First it would be much safer to do so, because you can be sure that the bear market is over and a new one is about to begin. Secondly, there is no way to know now which stocks will be the leaders of the next bull market right now. You need to see how the sectors act during the consolidation period to determine this.

Now the market is dropping so much that the 2002 comparison may not be the best one. We need to look now at 1974, 1987, and 1929 to get an idea of what is likely to happen.

One final note about 2002. The area of the 2002-2003 lows is a logical place to expect the current correction to come to an end - that would be the 750-850 range of the S&P 500.

The best case scenario would be a bottom like that seen in 1974. The consolidation period was shorter than the one seen after the 2002 bottom. After the bottom came in 1974 there was a quick lived rally and then a retest of the low. The market then went into a new bull market. One thing to note here is if you wanted to buy and hold you would have been better to do so on the retest, because you would have been able to buy the stocks that held up during the retest - they became the market leaders of the next bull market.

On the 1974 bottom the DOW was about 30% away from its 200-day moving average. Just like in 2002 - and just like at this moment.

When the stock market crashed in 1987 the DOW bounced back up and basically went sideways for a year.

The key thing you need to realize is that after the coming bottom the market is going to bounce back up and then simply go sideways for several months. I do plan on taking some trades and positions here, but I do not plan on diving in to be a long-term investor. There are some high dividend stocks I do plan on buying for the long-term, but as a whole most positions I take will be for trades.

First though a warning.

This is a chart of the 1929 stock market crash - and the bear market that came AFTER the crash.

If those that speak about deflation are right then this is what is going to happen. We'll bottom and then see the markets fall even worse over the next few years.

I do not think this is what is going to happen. But when you look at this chart you know that what behind it were horrible times. Our economy right now is in a similar situation. Banks are failing. There is a credit crisis. The President spoke of a Depression and stock market crash if his bailout bill doesn't pass. It then passed and the stock market crashed anyway.

I do not believe the government will allow what happened in the 1930's to happen again. But to prevent that from happening they will print money like mad and create an inflationary explosion. That is what we will see the start of next year - and it will be bullish for gold and commodities.

With that in mind, I still think it likely we'll see a new bull market start next year. But like always we will evaluate what the market tells us on an ongoing basis and follow its trend instead of just assuming the market is going to do what we think it will do or what we want it to do. That is why millions of people are sitting on losses right now and are wondering what to do.

Ok so now to what I may buy.

The rest of this article is for WSW Power Investor members only. Click here to access it.

Michael Swanson,
WallStreetWindow.com

Disclaimer: Michael Swanson is the President of USA Capital, Inc., which provides management, support, and research for institutional investors, hedge funds, and mutual funds. The ChartWizard is also an employee of USA, Capital, Inc. Both Swanson and employees and associates of USA Capital, Inc. may have a position in securities which they mention on WallStreetWindow or any of its services. In such cases, appropriate disclosure is made. Under no circumstances should the information received from WallStreetWindow represent a recommendation to buy, sell, or hold any security. WallStreetWindow contains the opinions of Swanson and the ChartWizard and is provided for informational purposes only. Neither Swanson, the ChartWizard, nor TimingWallstreet, Inc., which owns WallStreetWindow, provide individual investment advice and will not advise you personally concerning the nature, potential, value, or of any particular stock or investment strategy. To the extent that any of the information contained on WallSteetWindow may be deemed investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Past results of WallStreetWindow, the ChartWizard, or Michael Swanson are not necessarily indicative of future performance.

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