Russell 2000: Look for opportunities, not trends
In last year’s annual recap/outlook column, I fretted that the chart pattern resembled the topping formation we saw back at the end of 2000. Now that we have played out one of the most painful bear market collapses in market history, we come into 2009 with three intriguing scenarios: Will the market sink into a 1930s style depression environment? Will we see a chart pattern remake of the 1958 recovery surge? Or, will we move into an extended 1970s-style trading environment?
From a strict charting standpoint, the 2007 year-end formation was actually a much more interesting and dynamic pattern than what we see at the end of 2008. The doji-style top in 2007 made for a reasonably powerful warning signal about 2008. This year, the market simply shows a runaway bearish continuation pattern. Instead of turning points, these types of patterns typically become more about tracking the progress of support and resistance zones, and testing retracement lines to provide clues about the end of the bear market cycle.
Before we dig into the heart of this year’s annual chart study, there are a couple of “style” points to note. First, you’ll see that most of my historical reference utilizes the Dow; simply put, the Russell 2000 didn’t exist 80 years ago. Also, on the charts that accompany this column, you’ll see that I have broken down the Dow charts into various shorter time frames; if I ran all the data together, the charts lose perspective because of the massive appreciation in the Dow price series over the last 25 years. It’s quite interesting to see the various yearly patterns on their own merit. I have also shaded in recession time frames on the Dow historical percentage change chart.
This year’s collapse marked the largest one-year decline for the Dow since 1931, when the market tumbled a startling 52.7%. In fact, it has become fashionable in the popular financial press to refer to the current economic and market environment as the worst since the Great Depression of the 1930s. In 1929, the Dow peaked at 386.10; by the time the bear market collapse bottomed, the Dow hit 40.56, a jaw-dropping destruction of 89.5%. If the Russell 2000 were to evaporate 89% in this recession cycle, that would mean a bottom near 94 and a Dow trough near 1560 -- which is clearly preposterous. That would be like saying a mini-index comprised of the world’s largest bank, the world’s largest automaker and the world’s largest insurance company could drop 90% in a year. Oh wait, an index with Citigroup Inc. (NYSE:C), General Motors Corp. (NYSE:GM) and American International Group (NYSE:AIG) started out the year valued at $112.60 per share; the threesome finished off 2008 with a combined value of $11.48...a loss of 89%.
Now, I’m not saying that the market still has a decline of another 50% or more to come. I’m just saying that anything is possible under the worst-case scenario and that 2008 taught us that the unimaginable can take place. Looking back to that 1930s-era decline, the Dow closed out 1928 at 300; it didn’t finish out another year above 300 until 1954. An entire generation was born, graduated college and became parents before new highs were made. There is no mandate that says the stock market has to eclipse the 2007 peak anytime soon, that’s for certain.
When studying stock market action over the past 80 years, the first thing that pops out is how truly rare it is for the market to suffer a yearly slump of the magnitude we endured this year. Not only was 2008 the worst showing for the Dow since 1931, but this was just the third time over the last 60 years that the market tumbled more than 20% in a given year. The other two times were in 1974 and in 1937 (if you’re curious, the market was up 38% in 1975 and up 28% in 1938).
From a strict chart pattern standpoint, the only reference point remotely similar to this year’s formation that jumped out at me was in 1957. Although the market was only down 12.8% that year, the chart pattern was reasonably similar to the formation this time around, even though the percentage decline this year was far more severe. The market soared 34% in 1958 to new all-time highs and was up impressively in seven of the next 10 years.
From a story standpoint, there are two points in history that grab my attention. The first one – from the 1930s – we’ve already discussed a little bit. Let me say that the chart pattern reversal off the 1929 peak was far more dramatic and powerful than the patterns in play this time around. I’d also like to think that our policy-makers have the benefit of 70 years of historical knowledge and much greater technology to help us avoid a Great Depression-style collapse.
The historic story I keep coming back to is the market period in 1972-1974 and even extended forward into 1982; a reference point of perhaps a decade, with a spotlight on that three-year period in 1972-1974. Back then, we were finishing up an unpopular war in Vietnam, gas prices were through the roof and we were mired in the longest official recession since the Great Depression -- sound familiar? This time around, the recession began in December 2007, we are moving toward some kind of exit from the war in Iraq and last summer gas prices skyrocketed. And if the current recession extends beyond April 2009, then we will be mired in the longest running economic contraction since the Great Depression. The collapse from high to low for the bear market in 1973-1974 was 47%; this time around it was 57%. In 1972, the Dow closed out the year above the 1000 barrier for the first time in history. It didn’t close out another year above 1000 until 10 years later in 1982. That said, the lows in 1974 represented strong value. If we don’t take out the 2008 lows in early 2009, then it seems likely that the market will continue the sideways consolidation, with a gradual upside bias. Although I would prefer to see a 1958-style recovery rally to new record highs, as I’ve stated in previous columns I’m not in the “V”-style recovery camp; I think a more prolonged “L”-shape bottom is more likely.
What it all means is that 2009 (and perhaps beyond) is likely to be more of a “trader’s market” than a strong trending rally market. That’s not a style of stock market investing that today’s money managers are all that familiar with. Since 1982, the Dow has only been lower on an annual basis seven times. However, five of those instances have taken place since 2000, so perhaps money managers are becoming more adept at navigating these more unpredictable, unruly behavior streaks. If you know of a trading style or bias that worked in the 1972-1982 time frame, drop us a note--it could pay dividends this time around, too.
Ahead of the collapse this year I cautioned that any decisive breach of 650 in the Russell 2000 would trigger a big warning sign that the market was breaking down into a lower trading range. As we look ahead to this year’s trading, I will want to see the Russell consistently hold above 450 (and 416 below there) to avert a possible retest of the lows and to avoid any possible remake of the 1930s disaster. The upside weigh stations of note are at 550 and 650. A yearly range between 450 and 650 makes a lot of sense from a charting standpoint. If the market does get a rousing boost from all the economic stimulus plans and leaps back above 650 to get a “V”-style moving going, then perhaps we can all sit back a year from now and marvel at how the 1957 chart pattern pointed the way. I think it more likely that the Russell will grind along for a couple of years, struggling to bump through 650 with any conviction. These will most likely be times when trading support and resistance points, and extraordinary individual stock picking will be important.
Although the focal point of this week’s column is to look at long-term charts for the annual outlook, I do want to talk briefly about last week’s chart action. In recent weeks the market has started to behave in a different manner than what we saw during the relentless and harrowing freefall that characterized the dizzying collapse from mid-September to the November lows. And on the final day of the year the market finally closed above the recent correction highs, snapping the bearish behavior cycle of forging lower lows and lower highs that is often seen in a bearish move. This marks an important breach of bearish behavior, although the holiday-thinned volume takes some edge off the price action.
As we move into this week’s trading, it will help the recovery argument if the Russell can hold above 491 on a closing basis. There will be short-term resistance near 514.50 and 525 (and of course along the “figure” at 500), but the big test I’m now watching comes in near 550. On the downside, any slide back through 491 and then 473 would be troubling – especially as we push through a week highlighted by extreme economic event risk (as you’ll see in the calendar below).
The table below contains support and resistance points for the Russell 2000 to keep in mind heading into this week’s trading. For long-term traders, some of these key levels may remain in place for weeks...even months at a time. Those with a short-term horizon will lean toward levels that are more immediately in play. As time passes, we will build upon this table with levels that come into focus as important testing zones for trend analysis, and to act as road mark indicators for key reversal patterns.
From a trading perspective, I always keep a printout handy each day of my key support and resistance points for any stock or market I’m trading. It helps remind me of key areas to watch for signs of trend exhaustion, and also for potential entry/exit points for trades.
TECHNICAL ANALYSIS SUPPORT/RESISTANCE POINTS FOR RUSSELL 2000
- 890.16 upward channel resistance on monthly charts off 5-year run;
also fits with potential upside breakout of congestion zone
- 860.00 projected “figure” resistance off 15-handle testing zones on the ’06 rally
- 856.48 record intraday high set July 13, 2007
- 855.77 July 13, 2007 close; record high daily and weekly close
- 852.06 Oct. 11, 2007 high; bearish reversal peak on daily charts
- 830.01 previous high from the February 2007 peak; key swing line of note
- 815.00 key swing line
- 801.00 congestion resistance zone from November-December 2006
- 775.03 61.8% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse
- 764.38 new move high set August 15, 2008; approximate double top with June ‘08
- 762.89 previous move high set June 5, 2008
- 760.06 March correction low; key approximate double bottom formation support;
Near 50% Fibonacci of July ’06-’07 bull run; violated in November ’07;
Key swingline to watch
- 743.49 previous Aug. ‘07 collapse low; short-term support violated, now resistance;
Also near chart gap left by Jan. 2008 employment report news
- 726.19 previous double top in June/July 2008
- 720.50 swing point
- 700.00 “figure” swing line; no monthly close below here since Dec ’05 until Feb ‘08
- 685.00 20% decline off 2007 record highs; breached Jan. 2008, July 2008, Sept. ‘08
- 680.94 mild reversal low on daily charts Jan. 28; near 50% of the March ’08 bounce
- 668.58 July 2006 low; important bottom for summer correction; now resistance
- 660.00 short-term downside target on wedge breakout; now swing line
- 650.00 previous bear market move low set Jan. 22, 2008, former critical support zone
- 647.37 July 15 2008 low; approximate triple bottom with Jan ’08; Mar ’08; snapped
October 2008
- 643.28 previous move low set Mar. 10, 2008; now resistance
- 614.76 October 2005 bottom; now resistance on a bounce
- 606.42 April 2004 highs; now resistance
- 577.00 consolidation zone when market was bottoming in spring 2005
- 570.06 absolute low on spring 2005 bottom; now resistance
- 552.38 20-week moving average; nice trend support for bull run; smashed on
July/August 2007 collapse
- 551.00 short-term resistance from daily charts in October 2008; early Nov. peak
- 514.50 swing line
- 500.00 logical big “figure” swingline
> 499.45 Dec. 31, 2008 close
- 491.15 previous resistance line, broken Dec. 31; now support
- 473.50 20-day moving average
- 473.14 late November congestion range peak
- 442.10 previous bear market low set Oct. 28, 2008; bullish reversal on daily charts
- 433.36 new bear market bottom set Nov. 13; bullish reversal on daily charts
- 430.00 figure point near 50% “recession target” pullback
- 416.13 recent congestion zone trough
- 406.54 Nov. 21 close; lowest weekly close since April 2003
- 400.00 figure support matches with trading zone from 2002-2003
- 385.31 lowest daily close for the 2008 collapse
- 371.30 Nov. 21 bear market bottom; bullish reversal on daily charts
- 354.00 approximate value zone when market was bottoming in 2002
- 324.90 October 2002 bear market low
In addition to the printout of support and resistance points to watch, I also like to keep in mind where sudden volatility can spring into the trading mix from the typical release of economic data and Federal Reserve activity.
After a holiday lull the last couple of weeks, economic event risk picks up a full head of steam on the first full week of trading for 2009. As always, the big event will be Friday’s monthly employment report, but there are plenty of data mines to dodge before we get there. I won’t typically rate a Fed speaker high on my “risk meter” unless it’s the chairman, but I’m interested to hear the first Fed official economic outlook comments from Hoenig on Wednesday. In addition, car sales Monday, ISM services sector data Tuesday, ADP’s jobs report Wednesday and Thursday’s weekly claims all stand to garner attention from the number crunchers and traders alike. This is indeed a “wake up fast” start to the New Year!
The table below highlights calendar event risk for next week, with the emphasis on various economic reports. Our table below has a special “Risk Factor” designation, which is simply my assignment of risk to that event, ranging from 0 to 5, with 5 marking the highest risk for volatile market swings.
CALENDAR EVENT RISK ASSESSMENT
RISK FACTOR REPORT/ITEM (all times Eastern) Consensus
0 Construction Spending (Mon., 10:00 a.m.) -1.3%
3 Vehicle Sales (Mon., all day) 10.1 mln
0 Fed’s Yellen chairs subprime mortgage event (Mon., 1:15 p.m.)
2 Factory Orders (Tues., 10:00 a.m.) -2.5%
4 ISM Non-Manufacturing Survey (Tues., 10:00 a.m.) 37.0%
2 Pending Home Sales (Tues., 10:00 a.m.) -1.0%
4 FOMC Minutes (Tues., 2:00 p.m.)
3 ADP Employment Report (Wed., 8:15 a.m.) -480,000
3 Fed’s Hoenig “econ outlook” (Wed., 1:00 p.m.)
1 Treasury 3-year note action
4 Weekly Claims (Thurs., 8:30 a.m.) N/A
0 Consumer Credit (Thurs., 3:00 p.m.) $0.5 bln
1 Fed’s Hoenig “infrastructure spending” (Thurs., 4:00 p.m.)
5 Employment Report (Fri., 8:30 a.m.) -475,000/7.0%
0 Wholesale Inventories (Fri., 10:00 a.m.) -1.0%
2 Fed’s Lacker “econ outlook” (Fri., 12:30 p.m.)
