Is the Current Market Downturn About to Get Worse – Much Worse??

History suggests that it might!

We are becoming increasingly concerned that the 2009-2010 recovery in the FTSE might be ending. There are several signs that suggest this could be starting to happen although, we must add at this point, so far the current correction has to be viewed as nothing more than an overdue reaction to the extent and pace of the 2009-2010 recovery after the 2008-2009 collapse.

We were right when, back in June 2008, we warned of an impending stock market collapse (although we did suggest a 70% fall was on the cards but it actually fell by only (!!) 49% and we are now growing increasingly aware of the possible fragility of the recent recovery and of the potential for another, major, stock market crash.

Please do not think that we are forecasting another crash, we are not, but we are suggesting that it is well to be aware of the potential and so be able to avoid getting caught on the wrong side, should it happen.

Our present concern centres on two aspects; the first we have written about several times and that is the important support/resistance level for the S&P 500 Index which is at 1122. Having pushed its nose above this level the S&P 500 has fallen back to it and is struggling. If it cannot regain the upper ground above 1122 then it is likely to run out of support and fall off, possibly rapidly.

And, as the S&P 500 is the main driver for the London as well as for Wall Street a fall would quickly be replicated on the FTSE (as well as others).

The second centre of concern is the distinct similarities that exist between our current markets and what happened during and after the 1929 Wall Street Crash. This concern is growing and should not be dismissed as fanciful as significant historical trends do repeat from time to time. The similarities that exist look more substantial than the comparisons made over recent months by various economists as to the Great Depression and the West’s current financial tribulations.

We base our analysis purely on technical features of the price actions of the markets and we pay no regard to macro economics.

The chart below shows the S&P 500 Index over the last 2 years (we will come to the FTSE 100 shortly) -

(Click on any chart to enlarge it)

Note how the index fell by over 50% and then started recovered by 50% of the collapse and then just poked its head above the 1122 and immediately fell back.

Now let’s look at the Dow Jones Industrial Index for the same period. Note how it has done the exactly the same; big rise, big collapse and a recovery of 50% of the collapse and then poking its head above the 10345 resistance level and now has fallen back below it.

And the FTSE -

Now, we have seen this same pattern – a long rise (over years) followed by a price collapse and then a 50% recovery of the collapse…and that happened with dramatic and long lasting effect in 1929-30. Here is the chart of the Dow for that period.

And you can immediately see what is starting to worry us a little now – that the recovery only just poked its head above the half-way level of the collapse before it crashed back down again. And then it just kept on going down eventually taking out 90% of the value from the 1929 top.

Now, we are not suggesting that there is likely to be anything of that proportion involved in the coming possible correction of the market but we are suggesting that it is entirely possible for the market to follow a similar pattern at least as far as a retest of the March 2009 lows.

The 3 charts below show the potential danger to the S&P 500, the Dow and to the FTSE 100 index if they do continue to follow the same pattern:

Note in the case of the FTSE, it is still a little above the half-way support/resistance level. This could stand it in good stead, particularly as the current dominant trend is still the Uptrend, but it is a cause of concern that the current correction is gaining impetus and is likely to be greater than any previous correction made during the recovery uptrend since March 2009.

Conclusion:

No definitive change from Uptrend yet but the number of warning signs is slowly increasing. The worry is that, with the markets having thus far followed a very similar path to that established in the 1929-30 period, any continuation of that path will be the cause of major price falls in the coming months.

There is, of course, always the possibility that the markets will break with the historical pattern and make further progress after the current correction has run a short course but it would be wise to do two things -

1. Be prepared for another crash
2. Brush up on your Shorting skills

Just in case!

Alan Saunders

Chief Analyst

@ ShareHunter

29^th January 2010