It has been one crisis after another since the credit markets seized up in July 2007. This domino effect came to the very edge of disaster with the recent Bear Stearns fiasco. But to the rescue came the Federal Reserve, bailing out Wall Street's fifth-largest investment bank through JP Morgan. So when Bear Stearns was sold to Morgan for a bargain price -- which is still being negotiated as I write this -- there was the expected panic with huge selloffs across the board. And at some point in afternoon trading that selling panic ended, and you could see the buying come back into the market.
In the days following, there was an obvious shift in sentiment. The equity markets saw a rally; the commodity markets, which had been on a bullish rage, started cracking; and the US dollar actually started to rally. This shift in sentiment triggered the recitation of the word "capitulation" in the financial media. In fact, that's all we've read about in the next couple of days. Could it be? Was the Bear Stearns episode a signal that the stock market had finally bottomed?
Clearly, the intervention by the Fed restored some of the confidence that was lacking among consumers, not just to prevent investment banks from falling over the edge of a cliff but also by drastically cutting interest rates. But I wouldn't be making plans for that long-awaited trip to the South Seas just yet. There's still too much uncertainty in the markets. From a purely technical point of view, if you look at the chart of any of the broader indexes, you'll see that they're all still in a downtrend. It's going to take more than a couple-day rally to change that. In fact, we have seen this type of action in the market several times since March 2007.
So how can we say with any confidence that it will be different this time? No, we can't. We have to go back to the drawing board and analyze our charts. And it doesn't take more than a simple moving average or trendline to figure out where the markets need to be before we can say with complete confidence that the downtrend is over.
Nobody wants to go through bad times in the markets, but they are inevitable. There are still a lot of risks that need to be addressed, such as leveraged loans. And really, if you think about it, getting rid of all the junk and starting fresh with a clean foundation isn't necessarily bad. Until then, it may be best to sit on the sidelines and just watch the show.
Originally published in the May 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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