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Those are pretty much the questions traders and investors are all wondering. Knowing the right answers or at least guessing correctly could be very profitable over the next several weeks. The Nasdaq, S&P 500 and the Dow are all currently at levels where they have solid technical support. That doesn’t mean there won’t be another market downturn. But as we saw last week, the Federal Reserve certainly doesn’t appear willing to submit to a market meltdown. So it seems unlikely that stocks will fall much below these levels. I think it is more probable that major indices will regain some momentum and then possibly retest this level in the coming weeks.

As the chart below shows, these indices are currently at the same levels as in February and April. I added a red line to the chart to show this technically important level. If indices can advance past this level over the next few sessions, it will become an area of very strong technical support. The bottom portion of the chart is a moving average convergence divergence (MACD) of the Nasdaq. This indicator has turned upward from a very overbought level. That would seem to forecast that market momentum has shifted back to the positive side.

The mainstream financial media continues to overemphasize and even sensationalize difficulties in the mortgage and housing markets. Certainly problems are going to persist in these areas for some time–perhaps even three or four years. But the impact on the daily lives of most Americans will be minimal. 

Most of the people who will be hurt by the problems with sub-prime mortgages are those who took speculative positions. A speculative real estate position entails a high level of risk, just like a speculative stock position or any other type of speculative investment. These types of positions should only be taken by those who can accept the higher level of risk and handle the losses that could occur.

In the late 1990s and in 2000, many people foolishly allocated IRAs, 401Ks and other investment accounts into exclusively technology positions. They did this because they were greedy. They saw the big gains in the technology sectors and they put too much of their assets at risk in those positions. When the technology sector collapsed in 2001, many lost huge amounts of money they could not afford to lose. There are some investors who still have not fully recouped those losses and probably never will.

In the past few years, many people used gimmicks like interest-only loans or super-low adjustable rate mortgages to buy property that they really could not afford. Others took equity from their homes or cashed out retirement accounts to invest in real estate in areas where speculation was fueling rapid increases in property values. People in these types of situations are going to get hurt by this current crisis. 

Where is the money going?

When one sector of the market declines that usually means another sector rises. So far that hasn’t seemed to be the case with this correction. Major indices are down, but no other portion of the market seems ready to rise and take up the slack.

A ranking of the ETF universe shows that over the past three months, five of the top 10 performing funds are short funds. In other words, they are funds designed to make a profit when the market or a segment of the market is going down. The top fund over that time is Ultra Short Real Estate ProShares (SRS), up 43%. The other five include three Asian international funds and two energy funds.

Normally when running this type of ranking one or two market sectors really stand out as having the best performance. It might be technology funds, or emerging markets, energy funds, etc. Right now that is not the case. In fact, over the past three months, there are cases where short funds and long funds for the same market segments have essentially the same return.

This kind of directionless pattern usually occurs when the market is in transition. Certainly that seems to define our current situation. It is likely to take at least a few more weeks before we know whether the bull run is continuing for the stock market or whether we a going to see a more prolonged downward move. In the meantime, our best advice is to be defensive and to hold tight until a direction becomes more clear.
F.S.
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