The Day that Was - August 15th 2007

The S&P 500 has now lost all of the 2007 gains. The S&P closed on top of a relatively weak support level. But the DOW closed on a strong support region and this will likely give some of the brave the desire to try and do some buying tomorrow (reaction bounce). A reaction bounce can be short lived and we pullback again or it can be the start of a return to normal.

The famous Charles Dow (yes, the same person that the index is named after) developed the 'DOW Theory' back in in the early 1900's (there is an excellent chapter in the book "Technical Analysis of Stock Trends" by Edwards, Magee, and Basetti that talks about the DOW theory). It is the DOW Theory that to this day has a significant relation to our understanding of technical analysis. Charles Dow wrote that in order for a bear market to be 'confirmed' we will need to see a bounce back up to the first dip we had in the DOW (13200) last week. If we get a bounce and head back up towards 13200 and it can NOT break above it and then it starts to turn down then we are well on our way to confirming a bear market. As per the writings of Charles Dow we will be in a bear market if we drop below our current (12860) level. In technical analysis what this means is that when the DOW bounces up to the dip we had early last week and we can't get past it then we are seeing the evidence of investors not willing to pay any higher for stocks. This is a psychological failure to try anymore. When the desire to buy up the market and send it higher weakens then it is like being rejected by your first high school crush. You turn away and feel you will never try again. Then the sellers take over on the failed attempt of the buyers to move the market any higher and then we fall back even lower than before.

Now you may laugh at this description and you may even think it is all nonsense. But you must remember that the numbers and graphs of the various markets and stocks you see on your computer are connected to people. Those people are buying and selling. It is people that move prices. So when people see other people unable to break through a road block (resistance) then they turn away and go the other direction.

The study of technical analysis is at its core the study of human psychology.

The materials sector is in a free fall now and I see more pullback in the materials and this will be heavy on the markets. Financials just keep getting worse. And we have the Yen carry trade sneaking up on us again possibly. A bounce tomorrow does not cure the market. The underlying concerns of the people moving it is still there. And when (and if) we rally over the next few days and if it fails to move above the 13200 area then the fear remains just as strong and we turn back again and will likely go lower then where we are right now.

Tonight there is word that the FOMC may be forming an emergency meeting. If the FOMC does something dramatic then that will impact the fear levels (either raise them or lower them) and then the market will react accordingly. We don't know what the FOMC will do, or say, or what smoke signals they will send. The markets will react violently to anything bad and they will react feverishly bullish if the FOMC does anything that puts to bed all of this credit crisis the economy is facing.

In my opinion the FOMC is only seeing a few trees and they are missing the forest. There are signs of a weakening economy and they need to address this in a stronger language. If they continue to speak about the need to curb inflation then I feel you will see a strong market sell off. The markets are screaming recession now. The FOMC will need to come up with a plan so as to not create any more weakness in the markets and the economy as a whole.

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