It took a while, but the ongoing turmoil in developing markets hit the US overnight. The Dow Jones Industrial Index fell a solid 2%. At just under 17,000 points, that’s the lowest close since November last year.
The next level of support for the Dow is the October 2014 low, around 16,100 points. There’s a good chance that it will get there in the coming weeks or months. That’s because the Dow is now in a downtrend.
I pointed this out back on 27 July, here in The Daily Reckoning:
‘For the first time in a long time — since the bull market got underway in 2011 — the Dow Jones Industrial Index looks like heading into a downtrend.’
I then wrote:
‘That doesn’t mean a nasty bear market is upon us. But it does mean the market’s relentless rise may be over for the time being. The next important area to keep an eye on is the 17,000 point level. If the index breaks below here it will show a ‘topping out’ formation and the bears will begin to growl.’
Well, that ‘17,000 point level’ went last night. The bears are indeed beginning to growl.
The Aussie market looks set for another day of losses. The ASX 200 is approaching a very important long term support level.
Look, I have a bearish predisposition. I think this whole rotten market should just collapse and then we can get on with the process of building a sustainable economic system.
But the market doesn’t give a hoot what I think. The market is a law unto itself, a mega-organism acting under the collective will of mankind. You can assess probabilities, but you can never be sure of how things will play out.
So while I think the market should just head south from here, there’s no guarantee that it will.
And because we’ve operated in a manipulated market for so many years, and still have the memory of the 2008 collapse seared into our brains, we see every sell-off or correction as a precursor to a collapse.
That’s a natural thought process. It’s a protection mechanism kicking in. But it’s an emotional response. And emotions are the biggest enemy of the investor.
Just because central banks support the market every time it seems to falter, it doesn’t mean that corrections can’t happen anymore. They are a natural part of any market cycle.
Even after last night’s decline, the Dow is only down around 7% from its peak in May. That’s nothing to panic about.
The Aussie share market, however, looks a little worse for wear. Assuming another rough day today, the ASX 200 will probably finish the week down around 13% from its peak at 6,000 points.
The important question for you then, is this: is this just a correction, or the start of a bear market?
Australia, owning to its exposure to commodities, is more developing market than developed market right now, which is why stocks are under pressure. Yesterday, BHP Billiton [ASX:BHP] broke below its early year low and is now at its lowest level since 2009. BHP is clearly in a bear market.
But even the banks, which ultimately draw their value from the income Australia earns by selling commodities, are under pressure.
My favourite Aussie benchmark stock, the Commonwealth Bank [ASX:CBA], recently broke below $80, which was a catalyst for further falls. It’s now approaching a major support area, as you can see in the chart below.
The price action tells you that CBA’s profits have peaked. It tells you that the banks now face earnings headwinds. The question is how much. If the support region holds, then earnings should hold up ok too. If it doesn’t, then it’s telling you the Aussie economy is approaching recession, and that the highly leveraged banks are a major risk.
While all the focus is on the ongoing rout in commodities, it is the banks driving the change in sentiment in the Aussie market.
Last night, I sent the inaugural issue of Crisis & Opportunity to subscribers. I wrote about this shifting sentiment in the market…and how it was turning from bullish to bearish.
‘You may have noticed some stocks in your portfolio falling for no particular reason. This is investor nervousness at play. This is how shifting sentiment affects prices.
‘It means you have to be very selective with your stock picks. When the market is bullish, you tend to get a free kick. This is where the term, ‘a rising tide lifts all boats’ comes from.
‘But now the market is turning. It’s going from bullish to bearish. We’re not at the bear phase yet. And we might not get there. As I’ve said before, this correction could turn out to be just that — a correction before the bull market continues.
‘The charts below tell you what we’re looking for to determine whether the bull or the bear wins this arm wrestle.’
The bear is certainly winning right now, but as you can see in the chart below, the ASX 200 is not far off a strong area of support, which lies in the 5,000 to 5,100 region.
Given the steep falls experienced in the past few weeks, there’s a good chance you’ll see a rally pretty soon. From here you’ll get a good idea of the damage to investor sentiment.
If investors want to use the rally to unload their stocks, it won’t get very far. The market will turn back down and test support. If this support area doesn’t hold, then the bear will be back, bigger than ever…
Editor, The Daily Reckoning, Australia