The Contrary Investing Report
Investing and Trading News, with a Contrarian, Sarcastic Twist!


Why the Stock Market’s Next Leg Down Likely Began Today

by Brett on July 16, 2010

Since the stock market put in a short term bottom a couple of weeks ago (thanks to overwhelming pessimism), the mini-rally since has been a one-way street UP – until today.

This has been the trend of the market since about 2003 or so – it’s either up for many consecutive time periods (like 2003-2007, March 2009 – April 2010), or down for many consecutive time periods (2007 – March 2009, April 2010 – ?).

Also interesting is the “fractal” nature of the advance and decline streaks that is emerging within these larger trends.  Since the stock market topped in April, it’s been ebbing downwards in a relatively orderly series of “waves”, with the successive “lower lows and lower highs” that usually signal a downward bearish trend in place.  Stocks will decline for a few weeks – then they’ll increase for a few, but not take out the previous highs.  Then down for another few, taking out the last set of lows, and so on.

So when this rally began, regular readers know that we were licking our lips, looking for an appropriate entry point to “go short” once again.  I wrote before Tuesday’s open that it looked like the latest “mini-rally” was running out of steam, and that I had re-initiated my S&P short position (albeit too early…but when declines are this sharp, I’d rather be early than late.  And in this case, it worked out, as the position is now profitable).

Today’s decline was very powerful in breadth and depth.  It happened about when it should have (after restoring optimism to the markets).  So it looks like we may be setup for a resumption of the decline, with an upcoming leg that should take out the June lows.

S&P 500 price chart July 16 2010

Just about on cue, the S&P turned down sharply and violently after retracing much – but not all – of it’s previous decline.

(Source: StockCharts.com)

And how’d gold do today?  Not too hot – down $20!  The “safe haven” relic is hanging on for dear life, well below it’s June highs.  To me this looks like a repeat of gold’s 2008 performance – when it hung on longer than equities, but ultimately got body slammed by the Deflation Bird.

Remember, the last HUGE wave of deflation took no prisoners – hence I’m not convinced gold will be safe this time around either.

How should you invest during these deflationary waves?  Cash is probably the safest place to be.  For those of you with a speculative flair (like myself), it may be profitable to short the market, particularly on the inevitable bounces that get investors feeling bullish and happy once again!

In closing, we’re now profitable on our short position, and we’re planning to hold this baby through the next leg down, if that is what ends up transpiring.  A breach of the June highs would indicate we are wrong, at which point, we’d need to re-evaluate our stance.

S&P E-Mini Short Futures Position July 2010This short position was a big fat LOSER – until today!

And if you’d like to get caught up on our “shorting the S&P 500″ trades – here’s the last one we (fortunately) covered near the bottom of the last leg down.  It was far more luck than skill on timing :)


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  • Ron Maehl

    Hi!

    Like your work! If you’ld like, I could send you some eye-opening stuff about the magnitude of what is unfolding and how it corresponds to major planetary alignments, in particular Saturn & Pluto. We are in almost uncharted territory when combining public, private and corporate debt loads, unfunded social programs and pension funds, bankrupt state and municipalities, and the extreme outer planet alignments that portend almost a 2nd revolution starting this summer. As you know, markets disdain chaos and we’re headed into it big time.

    Astrology is not for everyone, but it did tickle such minds as: Pythagoras, Socrates, Plato, Hippocrates, Ptolemy, Plotinus, the ‘wise men’ that foretold Abraham, Buddha and JC, Attila, Charlemagne, Chaucer, Da Vinci, Galileo, Newton, Bacon, Shakespeare, Franklin, Emerson, Blavatski, Jung, Einstein, Reagan, etc, etc. Let me know if you’re interested…
    Ron

  • Simpsomi

    Brent:
    Great article and so timely for me.

    It may turn out that today was the best day of my trading career or the worst day of my life. When the market closed today, I had just about completely deployed all my ready cash and if this sucker drops as we think it is going to, then some time off to find a field of Roses and wallow around for a couple of months or so is definitely in the cards.

    When the market closed today, my portfolio reflected 700 Put contracts on the SPX with strikes starting at 900 strike down to the 500 strike in the Sept, Dec and March time frames. I plan to start taking profits on the September Puts in the 70% profit margin area when it gets there. The rest I will let ride down to the 600 area and then get out where ever they are at unless all hell breaks loose and it is dropping like a rock. IF….IF…that happens, then I plan to ride this puppy down like a wild bull coming out of the gate at the rodeo.

    Mean time, over the next few weeks, I will make the selection of Gold Stocks and/or their LEAPs to buy in anticipation of the ride back up, or to sell Puts on. Don’t know if I mentioned that up until the last week or two, I have been buying and selling Gold stocks and options on them almost exclusively.

    Hopefully, my balls haven’t intimidated my mind into a false agreement on this!

    Chuckling here as I type..
    ..Simpsomi

  • Mike

    I think the S&P-500 will churn a bit before moving lower. Last Friday was an unusually slow breakdown. To be honest the market is crashing almost in a ’slow motion’ fashion. Good if you are long as it gives you time to get out though which we have done extensively on all the rallies. Earnings season has been blah lately. I was reviewing the charts, I think we get that big breakdown in a month or month and a half (Sept) post earnings season.

    I was rolling up short positions with a stop at 1,120 on the S&P-500. Haha good thing I was not stopped out though.

    The questioning of if we are slowing down is over. I think one of 2 scenarios will play out:

    1. We go into a double-dip depression and things escalate 1000x worse than they are already.

    2. We release another stimulus (which was already hinted during the most recent FOMC meeting) and engage in a liquidity trap and an extended deflationary state, not to mention leverage the future of the country and potentially make things worse down the line.

    I think we already know #2 will occur which is unfortunate. If we just let the recession run its course thing we would not be exacerbating the issue even more.

    Here’s a trade I set up for the Euro for a break to 1.30 last week that I wanted to share. Worked pretty well actually. I have the first post, then the last one is an updated version.

    http://caps.fool.com/Blogs/time-to-buy-the-euro/418242

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