No Market Bottom in Sight Yet as the Fed Fails

By: Michael Swanson | Wed, Nov 28, 2007
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Since October 11, 2007 we have seen the DOW, S&P 500, and Nasdaq all decline in a correction. The three averages closed right on their August closing lows on Monday and bounced yesterday. This correction is not over and it is a sign that the Fed policy of lowering interest rates to try to force a stock market rally and bailout the US banking system is failing.

On September 18th the Federal Reserve lowered rates by fifty basis points and touched off a furious stock market rally as everyone became convinced that the Fed would print money nonstop to bail out the banking system and make the stock market go higher, even if that meant increasing inflationary pressures in the economy. They have continued to print more money. On Monday when the market weakened they injected over $7 billion dollars in the money supply. They lowered rates at the October FOMC meeting and are expected to do so again in December.

Nonetheless, the easy money policies of the Fed are not having the benefits everyone thought would come when the market was rallying in September and October. We have come a long way since then. The market is now trading below where it was when the Fed lowered rates at the September 18th FOMC meeting and credit spreads according to the LIBOR rate have grown as the interest rates that banks charge each other have increased.

On September 19th, no one imagined that the market would be lower than it was when the Fed lowered rates the day before.

The Fed has failed to stop the credit crisis and prevent the stock market from correcting again. What this means is that future rates cuts are unlikely to solve the underpinning problems facing the economy. It will simply take time to do that. It also means that they will not by themselves create sustainable rallies in the stock market.

At the moment the stock market is in a very precarious position. Right at the top in October I issued warnings in my October 5th monthly newsletter, titled Something is Wrong with the Banks, just a few days before the correction began. In this newsletter I warned of an upcoming correction and told subscribers that I would not be issuing anymore stock picks until we saw an end to it.

Since then I have stated over and over again in podcasts, bulletins, and free postings, that I did not see any signs of a bottom. Despite the market rally yesterday I still see no signs of a bottom. The market has yet to stabilize and sentiment in the options market according to the VIX and put/call ratio is still subdued while the Investors Intelligence survey is not registering the fear readings associated with bottoms.

When the market began to correct I had an initial target of 1450 on the S&P 500. If that broke I thought the S&P 500 would likely bottom above the 1400 level. We bounced off of that level yesterday, but unfortunately I do not think it is going to hold either, because the sentiment associated with bottoms simply isn't there.

This means that the market is at risk of having a major panic bottom like we saw in August sometime in the next week. The DOW could close near its August lows and then break it in a panic washout. If this happens it would likely be the bottom and I expect to be a big buyer, but the process will shake lots of people out of the market and cause others to fear buying.

It is exactly in those type of panic situations that you want to buy! You don't want to buy as the market is dropping and has one day fake out rallies that trap most people. You want to hold your powder and buy when you see signs of a real bottom. That takes a degree of patience and some guts. My main message for the past six weeks has been one of patience. If the market has a panic meltdown in the near future my message will change to one of action.

If the market corrects the way I think it will I expect to see gold stocks fall also and then bounce back afterwards in a furious rally. At the moment mining stocks are trading weaker than the market. This is exactly what they did before the August washout. The XAU has support at 163.48, the point of its November low. If it breaks the next support level is at 157.50, the 1/2 way point between its August low and November high. After that support is in the 148-150 area. I expect the XAU to bottom somewhere in the 150-157.50 zone over the next week.

The bad news is that means more pain for gold bugs over the short-term. The good news though is that once the XAU bottoms I expect it to rally straight back up to its 52-week highs and beyond. I have a target of 215 in the first quarter of 2008. A move from 157.50 to 215 would be a gain over 36%. Gold stocks may have their corrections here and there, but the failure of the Fed will only strengthen the power of gold. In bull markets, like we are seeing gold, dips bring buying opportunities. You make money by taking advantage of them.

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Michael Swanson

Author: Michael Swanson

Michael Swanson,

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