Securities Research Services

Tuesday, July 15, 2008

SPY Target $116

Sentiment readings are confounding here. The SPY has broken weekly support, the banks are failing, stocks are getting decimated on heavy volume, yet near term sentiment remains oddly stuck in neutral.

With so many thinking this market is oversold and due for a bounce, said bounce is very unlikely to occur unless the news improves. The Fed bailing out Fannie Mae certainly didn't do it.

From where we sit, the SPY is headed to the $116-$117 area before it offers even the hint of a chance for a tradable bounce. With that in mind, here's a scenario to look out for over the next few weeks.

Taking a look at the monthly SPY chart, note that the multi year uptrend currently resides at roughly SPY $116. The horizontal line just below the multi year uptrend (roughly $113) represents a 50% Fibonacci retracement for the bull trend which began in 2002 and ended late last year. And, the lower channel of the current downtrend meets squarely in the area between $113-$116 as well.

This offers us a pretty good target for this latest leg down. Assuming near term sentiment spikes to overly bearish levels when the SPY reaches this inflection point we should see a pretty good rally ensue from that level, offering a good spot to cover shorts and to start thinking about getting long again for a bounce.

Probabilities look fairly promising that we will see SPY $116 over the next few weeks. And probabilities appear to be fairly promising that at that point a multi week tradable rally to the upside will ensue.

Longer term things are not quite so clear. We hesitate to guess where this market is going after that. However, if one were to make the assumption that we are in a bear market that is similar in breadth and depth to the 2000-2002 bear market then an ultimate retracement all the way back to SPY $72 is not unthinkable.

There is a lot of noise out there arguing that this bear market is nearing its end and that bear markets typically don't give back much more than this current bear market has already given. That may be true, but perhaps this bear market is indeed a bear market like the one that followed the tech bubble. We are after all faced with a situation in the credit markets that we have not previously experienced. Given this fact, it seems reasonable to us to toy with the assumption that this bear market is not a typical bear market.

From a traders perspective we will say that this situation is vastly preferable to the low volatility, thin breadth market environment that was exemplified in the last half of 2006 and all of 2007.

During that low volatility environment, options sellers ruled the roost while traders struggled. Now that we are back in a situation where massive inefficiencies exist new opportunities are springing up that we can now exploit.

Just as an example, in 2003-2005 it was not unheard of to see stocks run up 100-200% in just a matter of days. These opportunities dried up over the last few years, but with this market correction those types of opportunities are sure to return once again.

Note: The B-Band continues to spread and the 50-week average continues to drop. This is a strong bear market and there is no reason to buy anything but gold and silver despite the fact that this market is technically oversold.

No comments: