Markets fell hard on Wednesday to mark the sixth day of consecutive losses for the S&P 500. The continued selloff experienced by the markets made the current pre-Thanksgiving week one of the worst performing in history.
The euro crisis and the political deadlock of the supercommittee are the culprits of the current selloff, according to the headlines.
I attribute the selling to a macro problem. There is an ongoing deleveraging process in developed Western economies that started in 2007.
Absent of new monetary and fiscal stimulus (QE2 ended this June and the U.S. and European governments are cutting public spending), there is no fuel to boost short-term GDP growth. The natural path to a protracted deflationary recession is resumed in the debt-burdened developed economies.
Since the U.S. Congress will probably not pass Obama's jobs bill," the Fed is doubtful of launching QE3. In Europe, there is no agreement for a local QE or TARP plan, and markets started to discount the deflationary-recession scenario and thus stocks started to fall.
Is this the beginning of a downward deflationary spiral that will tank markets sharply lower?
I don't know, but this threat of market apocalypse has surfaced various times during the last three years and has always been avoided, at least for the moment. Politicians will try to kick the can down the road and avoid the described scenario for as long as they can.
From a strictly technical point of view, markets should be reaching a bottom soon. We are currently extremely oversold and the returns from similar conditions are heavily skewed to the upside on a short- to mid-term basis.
My personal approach of gauging the breadth and participation of the world markets, the market monitor, is showing that 90 percent of its components are oversold. It doesn't get more pessimistic than that. The recent August and October bottoms were reached with similar readings.
Two other oversold indicators I track are also flashing an extreme oversold signal on the market. The percentage of S&P 500 stocks above their 50-day moving average is 10 percent and only 1.8 percent are above their 200-day moving average.
On the other hand, 93.6 percent of S&P 500 stocks are hitting the bottom of their trend channel.
Another thing that is noteworthy is seasonality. The highest returns for the S&P 500 are achieved from the end of November till the end of the year. Coupled with the oversold conditions, this also skews expected market performance to the upside.
The market should bottom soon and a nice rally is to be expected. For the shrewd trader, this is an opportunity to make some trades to the upside, expecting a sharp oversold bounce. During the last three months or so, these types of trades have been the most profitable.
A signal that the market is getting ready to bottom is to watch the behavior of the leading growth and momentum stocks. As of late their performance has been dismal, but if you start to see that this group is holding up or rallying in a weak market, the reversal will be beginning.
Hopefully, this time it won't be different and the world will not end during 2011.
About the Author: Victor Riesco
Victor Riesco, a financial analyst and trader in Santiago, Chile, works as an independent adviser and educator and operates a brokerage and trading business for local investors. He is the founder and editor of www.globaltradingpad.com. Click Here
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