Market Update: The Danger Ahead

Before getting into the "danger ahead"....

I think if you read my posts and updates, you'll see that I really try to avoid using a lot of overly dramatic language.

Words that hint at simple black & white outcomes, like "never," "forever," "cannot happen" are rare. I almost never use the word "crash" either, because those are quite rare in market history as well.

The way I see it, we have enough drama in the market anyway. While it's hard to do so, we should at least try to remove ourselves from that drama. The best investors and traders look at bear markets - and bull markets - in un-emotional ways.

So when I talk about market dangers, it's out of concern for something that has reasonable odds of happening and could hurt people if they are unprepared.

So for our present-day market, the "danger ahead" - raised in last Thursday's post - would look something like what was seen back in the last half of the 2008-2009 bear market:

In 2008, the decline that began in late September that year trimmed 40% off the S&P 500's value. I don't really expect a decline of that magnitude to happen here. But a 20% decline, taking the index down to 3,000 or so, is certainly a possibility.

That's both the benefit - and curse - for someone like me who's traded and invested for many years and paid close attention to the markets each and every time.

You start filing away little comparison notes, and develop a healthy respect for how a bear market that seems bad...can get worse (just like bull markets that seem like they can't go any higher...somehow find the fuel to go far higher than many believed).

Filling the Gap

So that's the "big picture" danger above. In the immediate future, the furious selling last week is close to "filling the gap" created around November 9th.

You'll recall that's when the October CPI report came in more benign than economists expected, and investors all hit their "buy buttons" simultaneously...creating what I called a "breakaway gap" at the time as all the  markets leaped higher.

And perhaps what's most telling is that the riskiest part of the stock market - small cap stocks - has already filled its "gap" and looks pretty awful as charts go:

So as we head into this pre-Christmas trading week, I'm trying to keep two simultaneous thoughts in my head...

One, it's possible the markets simply drift - or even mount daily rallies. The pre-holiday period is typically a low-volume affair so if there's something for traders to get excited about, it wouldn't be hard to stage a nice rally or two.

But as we've seen before, it's possible for the markets to mount rallies, and yet do so within an overall bearish context. The overall direction of the market remains down until proven otherwise.

Jeff