Wall Street and investors waited anxiously for days to hear Federal Reserve Chairman Ben Bernanke’s Friday comments about the economy. As many economists and analysts predicted, while the chairman addressed the problems of high unemployment and a weak economy, he did not indicate that the Federal Reserve will be taking any new action to shore up the ailing economy.

His remarks came after a Federal Reserve meeting at Jackson Hole, Wyoming. It was the same setting a year ago where he announced the Fed’s plan known as QE2 (the second round of quantitative easing).

In addition to Bernanke’s dismal assessment of the economy, there was other bad news for investors today. Today the U.S. Commerce Department made a downward revision of second quarter GDP growth. Instead of the 1.3% growth rate previously announced, the rate was actually just 1%, according to the release from the Commerce Department.

There was also disappointing news about consumer sentiment. The August reading for the University of Michigan’s Consumer Sentiment Index was 55.7, down from 63.7 the month before. That was lower than previous forecasts and the fourth lowest reading ever. The Consumer Sentiment Index is considered an important leading indicator because consumer spending accounts for two-third of U.S. economic activity.

Finally, hurricane Irene is churning toward the East Coast and is expected to make landfall this weekend. People up and down the eastern seaboard are taking precautions to reduce the potential damage once the storm hits.

In spite of all of this negative news, stocks were higher during Friday’s mid-day trading—a sign that the downward pressure of the past few weeks might be lessening.

Below is a candlestick chart of the S&P 500 (SPX) over the past three months. The body of each candlestick reflects the area between the open and closing price of a security. The wick illustrates the highest and lowest traded prices of the security during the time interval represented. If the security closed higher than it opened, the body is white or unfilled, with the opening price at the bottom of the body and the closing price at the top. On losing days, the body is red, with the opening price at the top and the closing price at the bottom.

Some things one might notice in looking at the chart are how the red (down) days have dominated over the past few weeks. Also, the size of the candlesticks has been considerably larger during that time, indicating that daily volatility has increased.

Obviously market risk remains very high right now. But today’s events provided plenty of reasons for another dramatic slide in stock prices. The fact that markets held up fairly well instead could be a sign that the recent market instability is finally blowing over.

Flint Stephens

While major stock indices rose from their lows of last week, it is likely to take much longer before we know whether the current support level will hold.  After a sharp correction, it normally takes much longer before stocks can recoup those loses. In most cases there is a sideways consolidation before stocks gain enough momentum for a renewed advance.

We last saw this situation in the summer of 2010. After the Flash Crash in early May and a second leg downward later that month, stocks traded mostly sideways for the rest of the summer. You can see what I am referring to on the chart below. The green highlighted circle shows the consolidation that took place after the steep slide in May. It would not be surprising to see stocks follow a similar pattern in the next few weeks.

Of course another possibility is that stocks could slide sharply again and usher in a new bear market and the double-dip recession that some economists are predicting.

Technical indicators are telling us the worst is probably over. The bottom portion of the chart shows a moving average convergence divergence (MACD) of the S&P 500. The MACD reached an oversold level last week and has turned upward again. So far this indicator and others have not reached a positive level, but rarely does the MACD stay at this oversold level for a prolonged period. Risk, however, is still high. Today there is a great deal of fear and emotion among investors. Almost any negative news or event could provoke investors to sell in a panic that would be difficult to control.

Perhaps the biggest danger to U.S. stocks right now comes from outside the United States. Ironically, the U.S. received plenty of criticism in recent weeks about its failure to reduce its long-term debt obligations and some of that came from countries that have their own serious debt issues. Today we have a global economy. Events in Western Europe, China, South America or almost anywhere else can have a significant impact on U.S. stocks.

Perhaps the biggest threat to global markets right now is the financial crisis threatening the eurozone and its official currency the euro. Several member countries of the eurozone have debt problems significantly more critical than the U.S.  The situation has caused some economists and analysts to speculate that the European Union and the euro might be dissolved. When asked about that prospect in an interview with Der Spiegel, billionaire investor George Soros said, “If the euro were to break up, it would cause a banking crisis that would be totally outside the control of the financial authorities. So it would push not only Germany, not only Europe, but also the whole world into conditions very reminiscent of the Great Depression in the 1930s, which was also caused by a banking crisis that was out of control.”

Someone recently sent me an email touting the old “buy American” philosophy. The general concept was that because the U.S. economy is struggling, we need to keep our dollars at home. That might have been sound thinking 30 years ago, but it really doesn’t work today. For example, my oldest son works In Wyoming as a sales rep for a company headquartered in Switzerland. I have neighbors who are employed by U.S. companies but they work overseas. Many of the largest U.S. companies generate a significant portion of their revenue outside this country.

The U.S. investment community is closely linked to Europe. The New York Stock Exchange and the American Stock Exchange each merged with Euronext in 2007 and 2008 respectively.  Euronext also controls stock exchanges in London, Paris, Amsterdam, Brussels and Lisbon. Anyone who thinks there is some way to insulate the U.S. economy from what happens in Europe is wrong.

Right now, it is impossible to predict how the European situation will play out and what the exact impact will be on global and U.S. markets. Certainly U.S. investors should be watching events closely and be prepared to take action to protect their investment portfolios.

Flint Stephens

Back in 2009, numerous investment analysts and economists talked about the “Lost Decade.” The term came about because in the 10-year period from the end of 1998 to the end of 2009, most major stock indices lost money. Unfortunately, more than two years later the situation has not improved.

The latest market volatility is really just a continuation of an extended sideways pattern. And given the current economic conditions, it could easily continue for another decade. This most recent decline pushed the S&P 500 back to the 1,100 level—the same place it was for much of 2010, the end of 2009, the end of 2008, most of 2004, the beginning of 2002, the end of 2001, and much of 1998.

Of course since 1998 the S&P 500 has frequently been higher than 1,100 and has been lower for extended periods. Whether the past 12 years were a bust or a boom for investors depends on when they bought and sold because not many remained fully invested in the S&P 500 Index for the entire period.

Below is a chart showing the price moves of the S&P 500 going back to the beginning of 1994. It is on a logarithmic scale, meaning that the price moves are proportional. What is readily apparent about this latest market slide is that while it has certainly been painful, so far it is still just a blip compared to the declines that began in 2000 and 2007. Unfortunately, no one can predict whether the current episode is over or whether this downward leg will continue. Certainly, every investor understands that risk is high at this juncture.

I added a red line to highlight the 1,100 level which seems to be providing both support and resistance for the index during this period. With the market activity of the past week, once again the S&P 500 is fluctuating around the 1,100 mark.

For several years managers at Strategis Financial have recognized that stocks are in a long-term sideways pattern. We have warned clients that this pattern might persist as long as 20 years because this type of long-term sideways moves have occurred several times in the past. The most recent example was 1965 to 1982 where over a 17-year period the Dow Jones Industrials Average had a cumulative return of less than 1%.

Currently the economy is facing many obstacles. Still the situation is not as bleak as it was in 2008, so it seems unlikely that this correction will be as severe as the losses that occurred then.

Flint Stephens

Big market declines are always painful, whether they occur over several weeks time or over just a few days. Major slides like the one that occurred Thursday are particularly difficult because we don’t know how much additional damage there will be. The emotional reaction from many investors is to bail out before the situation gets worse. When everyone starts heading for the exits, the downturn can accelerate. Sometimes getting out quickly turns out to be a good move. Other times it is the wrong approach.

Looking back at the recent past can often help put the current situation into perspective. Many investors have already forgotten about the May 6, 2010 Flash Crash. Slightly more than a year ago the Dow Jones Industrial Average plunged about 900 points—or about 9%—only to recover those losses within minutes. It was the second largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) on an intraday basis in Dow Jones Industrial Average history.

The chart below shows the New York Stock Exchange Composite over the past two years. The Flash Crash is easy to see and the market slide of the past few sessions looks quite similar. In 2010 the Flash Crash was followed by several months of market weakness. But investors who waited a few days after the crash were rewarded with better exit opportunities. And by the end of the year, last summer’s decline was completely erased.

Another similarity between this week’s decline and the Flash Crash is that there was little technical warning before either event. The middle portion of the chart is a moving average convergence divergence (MACD). Before the Flash Crash it was positive and had not reached an overbought extreme. During the most recent event, The MACD had turned up and was just moving into positive levels—something that usually indicates an advancing market. The past few days have pushed the MACD to an oversold level that usually precedes a market turnaround.

The bottom portion of the chart is a stochastic oscillator. For several days it has hovered at an oversold level indicated that an upturn is likely.

The chart below shows daily prices changes of the Chicago Board Options Exchange Market Volatility Index (VIX) over the past two years. VIX is a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index, it represents one measure of the market’s expectation of stock market volatility over the next 30-day period. As expected the action of the past few session caused the VIX to spike. But it is still well below the highest levels of 2010. Some managers buy the VIX as a hedge against market declines like the current situation. If this downturn continues, the VIX will go higher. But it can move down as quickly as it goes up.

Most investors are aware of the problems facing the U.S. and global economies. Much fear and uncertainty remains. That emotion is undoubtedly the fuel for this downturn.

A week ago Congress was reaching a debt compromise after months of stalemate. Second-quarter corporate earning for the majority of companies that make up the S&P 500 were better than anticipated. Today’s unemployment report was slightly better than expected. These are all things that should be pushing stocks higher rather than precipitating a free fall.

Because there is no identifiable technical or fundamental reason for this steep slide, it is hard to forecast when it might end. But past history is an indication that there will be a better exit opportunity for investors who are patient.

Flint Stephens