This Stock Market Correction Will Lead to a Nice Rally - Mike Swanson (06/13/11)
The stock market has been falling now for six straight weeks. Corrections like this usually end when you get a panic washout day in which 90% of the volume on the NYSE and Nasdaq is on the sell side, the put/call ratio closes above 1, and the VIX jumps up a couple of percent in a day. If you go back for eight years you'll see that this has been a reliable indicator of the end of a correction with a few exceptions when the market went into a big drop, such as what occurred in the Fall of 2008.
This is a little disconcerting now though, because two weeks ago we saw such a washout day in the market, but instead of bottoming the major market averages paused a day and continued lower. The Nasdaq, S&P 500, and DOW all managed to close last week below their 150-day moving averages and appear to be headed down towards their next support levels - their 200-day moving averages and lows set in April. That's about 1250 for the S&P 500.
Of course the major three market averages could go below their April lows. But if they do they probably wouldn't do so by much. Right now the most important thing to do is just be patient and wait for the next panic bottom and use it as an entry point.
I think it most likely that once the next bottom comes in we'll see the averages rally back up to their recent highs again. We'll probably get nice moves too in commodity related stocks and in gold and oil prices in particular which have held up well during this overall correction. The price of gold has barely dropped at all.
Since the market now has been falling for six weeks that rally is likely to be a very fast and furious one once it starts. At the beginning of the month I made note of a potential bottom when we got a panic selling day, but at the time also said it wasn't likely that the market would rally straight back up, because of the price pattern it had made. But the situation now is different, because the longer a correction takes place the bigger and faster the rally can be once it ends.
But I still think it has a little bit more ways to go in time and price before it ends. Probably another week or so.
One reason why is that with the action last week this is now becoming a more meaningful correction - and those type of corrections normally end with the VIX spiking up for several days.
We have not seen that yet. In fact the other week the VIX barely went up while the market fell - which was a warning sign that the correction would continue.
At the moment people are still a little complacent. As the Wall Street Journal Reports this morning:
"One reason investors appear less worried this time is that last year's troubles didn't last. On the back of a Federal Reserve program to stimulate U.S. financial markets through heavy bond-buying, stocks recovered all their losses last year. The Dow surged almost to the 13000 level before topping out in April of this year...Having been bailed out before, investors are reacting to the current troubles with less anxiety. The so-called "fear index," a measure known as the Vix, which reflects the use of options by anxious investors, has remained relatively quiet during this period of declines. On Friday, it remained below 20, far from the panic level of 30 or 40. The Vix is tracked by the Chicago Board Options Exchange."
So for now being a bit more patient before doing any buying makes sense, but if the market does go lower don't get too despondent, because a fast rally will be the result - and it will be worth buying into the next round of panic selling that comes before it.
