As the global markets are fighting once again with a new episode of the “subprime” crisis, the timing is obviously more than appropriate to have a look at the potential perspectives of the equity indices. With the collapse of Lehman Brothers [NYSE:LEH], the Bank of America’s [NYSE:BAC] rescue offer for Merrill Lynch [NYSE:MER] and the coming difficulties of AIG [NYSE:AIG] and other institutions, the financial crisis may be peaking and strongly argues for a new markets’ plunge.
Even Alan Greenspan claims that he has never seen a crisis like this one, and that it will take some time to overcome it.
Yesterday the Dow Jones fell by 4.42% with a closing price at 10,917.51 points. It is down 17.7% year-to-date.
First, the big picture: the index should test the low posted last July (point D on the chart), probably in the coming trading session. This level (around 10,800 points) corresponds to the 50% Fibonacci retracement ratio of the bullish trend occurred between March 2003 and October 2007 (between points A and B).
The low posted in January corresponded to the 38.2% retracement level (point C).
On the medium-term chart, the technical indicators show that, even before the plunge of yesterday, there were already bearish signals that had been recently triggered.
The Stochastic Momentum Index (SMI) is based on the Stochastic Oscillator. The difference is that the Stochastic Oscillator calculates where the close is relative to the high/low range, while the SMI calculates where the close is relative to the midpoint of the high/low range. The values of the SMI range from +100 to -100.
The SMI is interpreted the same way as the Stochastic Oscillator. Extreme high/low SMI values indicate overbought/oversold conditions. A bullish signal is generated when the SMI rises above -50, or when it crosses above the signal line. A sell signal is generated when the SMI falls below +50, or when it crosses below the signal line. Also look for divergence with the price to signal the end of a trend or indicate a false trend.
Here the 20-day SMI has crossed below its signal line on September 5: it’s a bearish signal. The same signal has been confirmed by the MACD. It means that the rebound occurred after mid-July did not succeed to gain some further positive momentum. The targets are now on the downside.
In this scenario it is probable that the price action will break down below the 50% Fibonacci level, therefore below 10,800 points. The objective will become the last Fibonacci ratio (61.8%) which is set around 10,000 points.
Good Investing,
Gabriel
