4 Bearish Mega Trends:
U.S. Deficit
For a moment, take a mental journey with me back in time. We are now in early 2008. The major indexes a la S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI), and Nasdaq (Nasdaq: ^IXIC) are slowly coming off their all-time high, but the collapse of Lehman Brothers has not yet hit the news.
Unbeknownst to most, the perfect financial storm is brewing. Once the storm hits, it is much worse than anyone expected. But, the eventual damage is limited. Why? Because, the government steps up and does what it takes to prevent the financial system from failing.
Today has the feel of early 2008. Another perfect storm may be brewing. Will the government be there to do what it takes to support 'too big to fail?' No! In 2008 financial companies were in trouble. In 2011 entire countries (look at Europe and the U.S.) are struggling to escape the grip of delinquency.
A Decelerating Generation
Starting in 2011, more than 10,000 baby boomers a day will turn 65, a pattern that will continue for the next 19 years. This dry humor cartoon encapsulates the problem retirees' face today:
Two older gentlemen are having a drink. One says: 'As a Baby Boomer, I never thought the boom would be the sound of my retirement accounts collapsing.' He'd like to sip on a nice Scotch while enjoying a steak, but has to settle for water and free bread sticks at Olive Garden.
Most retirees still haven't recovered from the lost decade. Let's make the term lost decade more personal. A 55 year old with $100,000 in his retirement account at the beginning of the year 2000 and a 6% projected rate of return, would have $201,419 today.
The S&P trades 20% below its 2000 level. Courtesy of the lost decade, that $100,000 in the year 2000 has turned into $80,000 today (perhaps less if invested too aggressively). In other words, many retirees may have to get by on less than half of their expected nest egg. In addition, their home, rather than being an asset (many considered it an ATM a few years ago), has turned into a liability.
It doesn't take much imagination to see that strapped retirees are bad for economic growth. When the focus is on survival rather than pleasure, sectors like technology (NYSEArca: XLK - News), retail (NYSEArca: XRT - News), and consumer discretionary (NYSEArca: XLY - News) suffer.
In addition, baby boomers that have been buying stocks for decades (think of all the 401k money) are now turning into sellers of stock.
Low Interest Rates
Low interest rates are great for the U.S. government because it reduces debt payments on Treasuries and businesses wanting to expand. Unfortunately, businesses don't feel like expanding or even hiring and for pretty much everyone else low interest rates are negative.
Some try to sell the idea that low interest rates are good for stocks (NYSEArca: VTI - News) because money will flow from low interest bonds into stocks in an effort to get a better return.
The chart below plots the Nikkei against Japan's version of the discount rate. The discount rate has been below 1% since 1995. At the same time the Nikkei has dropped from above 20,000 to below 10,000. Much of this happened during a raging global bull market. Imagine what a global bear market can do to U.S. stocks.
Low interest rates are a double negative because they reduce available spending for retirees who need to get as much income as possible to survive.
Coming to a Head
The above three bearish trends were highlighted in detail in various 2011 ETF Profit Strategy Newsletters. Due to those, and other mega trends, the Newsletter has been expecting a major market top.
For much of 2011 however, the expectation of a major market top was postponed until the ideal target range was reached. The April 3 ETF Profit Strategy update included a precise range for a major market top: 'In terms of resistance levels, the 1,369 - 1,382 range is a strong candidate for a reversal of potentially historic proportions. '
Why was S&P 1,369 - 1,382 a candidate for a reversal of historic proportions? The chart below, published by the ETF Profit Strategy Newsletter in March and many times since, has the answer.
What you see is a giant M, or head and shoulders top. The right shoulder was made up of the parallel trend channel that connects the 2002 and 2009 low, with the 2000 high. In April/May the upper line of the trend channel ran through 1,377. Additional resistance was provided by Fibonacci levels at 1,389 and 1,369.
On May 2, the S&P briefly spiked as high as 1,370.58 before retreating and eventually dropping 18% in twelve trading days (July 25 - August 9). Once the S&P dropped below the 200-day SMA it entered free fall territory.
The July 28 ETF Profit Strategy update warned that: 'A break below the 200-day SMA and the trend line may trigger panic selling.'
Why Stocks Will Rally
From top to bottom (once the bottom is in), the S&P will have fallen more than 270 points. No doubt this kind of move validates a counter trend rally. October has a reputation as bear market killer and even though I don't think October will 'kill' this bear market, it should be the spring board for a nice year-end rally.
Sentiment and various technical indicators and studies also suggest that a price low is close. End of original article.
Updated Short-term Forecast
The S&P bottomed at 1,075 on October 4. A couple days before (October 2) the ETF Profit Strategy update recommended to sell short positions at 1,100 - 1,090 and buy long and leveraged ETFs as soon as the S&P moves back above 1,088. The ideal bottom pattern was described as follows:
'The ideal market bottom would see the S&P dip below 1,088 intraday followed by a strong recovery and a close above 1,088.'
Even though higher highs are expected before year-end, I recommended to sell long positions at 1,204. The S&P has simply moved too far to fast (which has been great for our long positions, but there's no need to get greedy). A correction is now likely.
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