The Technical Damage of this Correction is Severe

By Graham Summers       Feb 10 2010 3:02PM www.gainspainscapital.com

Earlier this week I explained why the market began to rally sharply last Friday afternoon. Today we’re looking at where the market is from a technical perspective. Be forewarned, if you’re a bull, what follows isn’t pretty.

For starters, the first thing we need to keep prominent in our thinking is that the market rally from March 2009-January 2010 was largely a technically driven rally fueled by easy money from the world’s Central Banks: Governments around the engaged in an unprecedented amount of stimulus/ bailouts and much of this money found its way into the financial markets.

How do I know this?

The S&P 500 rose 60+% in the US and 100+% in many emerging markets.

While the underlying fundamentals continue to deteriorate (the exception being corporate profits which have only marginally improved from March’s “the world is ending” results):

Again, this market rally was fueled by loose money. And it was driven by technical’s, not fundamentals:

As you can see, the S&P 500 broke above its 50-DMA in March 2009 and didn’t look back. There was only one real violation of the 50-DMA during the entire 10-month rally. However, even then we got a massive bounce off the 200-DMA resulting in the market starting its next leg up. Of course, the Fed’s juicing during options expiration week in July didn’t hurt.

Aside from that correction, stocks stayed above their 50-DMA from March until recently, using that line as support time and again during the rally. Like I said, this was a market rally that was driven by technicals.

With that in mind, we are now going to examine this latest correction from a technical standpoint.

First and foremost, we see that the S&P 500 sliced cleanly through its 50-DMA like a hot knife through butter. The picture is even uglier when we note that the S&P 500 also broke through both 1,110 AND 1,190: two lines of major support that were established during a two-month trading range.

Thus we now have three former lines of support (the 50-DMA at 1,111, 1,010 and 1,090) that will now serve as overhead resistance should the bulls attempt to regain control and kick off another rally.

In contrast, the next lines of major support are the November low (1,040), the October low (1,025) and the 200-DMA (1,019).

Thus we are in a range bound market with the bulls and bears battling it out until the market either breaks above 1,090 or falls below 1,040. My take is that the general trend is now down. We could see a bit of a bounce here, perhaps even an attempt at 1,090. But ultimately the market is going lower and will break below 1,040.

Indeed, the only reason stocks seem to be rallying at all is due to more talk of moral hazard/ bailouts.

Is this how simpleminded the entire financial world has become? That stocks rally (people get bullish) because someone (a country this time) might get bailed out? So when the UK gets bailed out… or the US has to be bailed out (by Martians or some non-Earth dwelling organism since no country on the planet could bail us out) the S&P 500 will be trading at 10,000?

Let’s be totally blunt here. The fiscal policies/ bailouts/ stimulus plans of the world’s central bankers have fixed nothing. Zero. Nada. Nothing. Why? Because shoveling garbage debt from the private sector onto the public’s balance sheet DOESN’T pay off the debt or fix the debt problem.

It’s really quite simple. I’m not sure why the expert economists and pundits don’t understand this. Using this logic (shift debt around, but don’t pay it off or default on it) you could easily argue that the best way to deal with moldy cheese in the refrigerator is to hide it under the kitchen sink. Sure the fridge looks better, but pretty soon the entire kitchen stinks. And the cheese keeps getting moldier.

That’s’ the situation facing Greece, Portugal, Spain, Dubai, Italy, Ireland, the UK, the US, and basically everyone on the planet. DEBT. It stinks. And moving it around doesn’t make it (or the interest payments) go away.

No, there are truly only three solutions to a debt problem:

1. Pay it off
2. Default
3. Inflate it away (a variation of #1)

“Pretend it’s not there” and “move it around and pray the economy recovers before it becomes an issue” are not solutions. They are illusions. The illusion that everything is under control. The illusion that trillions of dollars is NOT a problem. The illusion that Ben Bernanke and the world’s central bankers (NONE of whom saw this coming and ALL of whom perpetuated policies that created it) can somehow fix the situation.

Folks, the world’s bankers haven’t solved the Crisis. The fact that we’re now talking about bailing out entire countries should make this obvious. What’s next? Continents? The entire planet Earth?

At some point this belief “that bailouts will work” will smash into a wall. It may actually already be occurring. The markets didn’t even take out initial resistance in any meaningful way yesterday. Sure, we had an explosive open and massive rally on bailout rumors around noon. But even then the market cooled and closed below resistance.

If a Greece bailout emerges, don’t let it fool you. Spain, Portugal, Ireland and Italy are all in trouble (as is the UK and US for that matter). Any rally or positive spin that comes from a Greece bailout (if it happens) will be short-lived. The fact that we’re only in February and already the sovereign defaults are lining up should tell you how this year is likely going to turn out.

Which brings us to Gold. Many investors are asking, “is it a safe haven in this mess?” Well, let’s take a look at the chart.

Gold broke through support at $1,076. On top of this the 50-DMA (1,129) now stands as resistance. The Gold bugs will need to push the precious metal above both of these levels and keep it there if Gold is going to launch another real leg up.

I remain bearish on Gold as the Dollar rally continues to gain strength. Indeed, I think that in the near to intermediate term we could easily see Gold drop to test the 200-DMA at 1,015. The precious metal has come too far too fast in the last 12 months and we’re due for a shakedown that would result in many of the speculators selling. A drop to test the 200-DMA would bring the metal to a sounder base from which to begin its next sustained leg up.

Long-term I am a Gold bull as the debt problems of the world come to the forefront. But in the near-term (next few months), Gold will fall along with commodities if the Dollar continues to rally. Until we get a full-blown flight from paper money underway (we might be seeing the very first ripples of this in the last six months as Central Banks become net buyers), Gold is still trading like a Dollar hedge. Once it is recognized by the world’s investors as a currency in of itself, things will change and Gold will be much much higher.

Good Investing!

PS. If you’re worried about the future of the stock market, I highly suggest you download my FREE Special Report detailing THREE investments that could shelter your portfolio from any future collapse.

I call it The Financial Crisis “Round Two” Survival Kit. The three investments detailed within its pages can potentially protect your portfolio from any severe downturn in stocks. Even better, they can potentially also show you terrific profits if timed appropriately: during the fall of 2008, they all returned double if not triple digit returns.

Graham Summers

****

To pick up a FREE copy of The Financial Crisis “Round Two” Survival Kit, swing bywww.gainspainscapital.com/roundtwo.html TODAY!