The Stock Market Approaches an Important Inflection Point

| July 29, 2010

The initial estimate of second quarter GDP will be released tomorrow morning, just as stocks approach an important inflection point across multiple time frames. The topping formation that we have been monitoring for the past several months still favors an eventual breakdown and resumption of the secular bear market from 2000, but what happens over the next two weeks could potentially tell us a great deal about both short-term and long-term direction.

At any given point in time, we are tracking multiple scenarios and assigning the most likely ones approximate probabilities. The two most likely possibilities with respect to the weekly trend differ only in their near-term forecasts, and market behavior during the next five to ten sessions should resolve the debate between the two outlooks. The first possibility is that the most recent intermediate-term cycle low (ITCL) occurred in early July, suggesting that the current rally is likely to continue until the end of August.

This scenario would be validated if the stock market either moves higher or consolidates in a sideways pattern over the next two weeks. We would then expect a reversal to occur in late August or early September followed by a move to new long-term lows, confirming the start of a new cyclical downtrend from late April. There is, however, a second possibility that is even more bearish. If the last ITCL did not occur in early July, but instead formed in early June, then the bullish phase of the current intermediate-term cycle is almost over, suggesting that a reversal is likely to occur during the next week or two.

If this second scenario unfolds as projected, we would expect the S&P 500 to decline sharply over the next two weeks before breaking down to a new long-term low during the second half of August, also confirming the start of a new cyclical downtrend from late April. Thus, both possibilities result in an eventual confirmation of a new cyclical downtrend. They merely differ in the timing of their reversals. For now, it will be important to monitor broad market behavior closely over the next several sessions.

If stocks are able to hold at these levels or even move higher next week, the current rally should continue at least until the end of August. However, if stocks decline precipitously instead, the next long-term breakdown is likely only a couple of weeks away. The process of identifying the most likely scenario will begin tomorrow with the GDP report, as the market reaction to this closely watched data release should provide an initial indication of near-term direction.

Category: Commentary, Market Update

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