Comment 61: How far will US stock prices sink? (Based on a technical analysis) (Oct. 7, 2008)

In Comment 1 we have said not to project stock market movements based on the reasoning that even an almost perfect projection will defeat itself by nature. For such a self-defeat to occur the projection must satisfy the following two conditions: (1) the projection is followed by a massive crowd in stock markets, and (2) The projection gives precise date when the projected events will occur. Both conditions are not satisfied here. At this juncture of very unsettled financial and economic conditions which this website has been following closely, we believe that it is irresponsible to our readers if we do not reveal our view about the future course of US stock prices in general.

Technical analysis of stock prices is an empirical method, trying to derive future directions of stock prices from past experiences. Quite a few aspects of technical analysis are dubious in nature and some are even outright irresponsible. However, there are some aspects, like over-bought-over-sold conditions and rough support-and-resistance levels, are quite helpful if used carefully. This warning in this comment is based on such a technical analysis.

SP500 index is used as the representation of US stock market here. The levels of 800 and 500 for SP500 index are two crucial ranges. In the bear market following the burst of the Clinton stock market bubble, SP500 index bottomed out near 800 level in the stretch from 2002 to 2003. Apparently around 800 there is a strong support for SP500 index. On Oct. 7, 2008, SP500 index broke below 1000, losing nearly 600 points from its all time high set in 2007. With the ferocity of the decline, we fully expect that SP500 index will fall to 800 and retest the support there. If the 800 support is breached, the next strong support for SP500 index is around 500. We will explain why this 500 level is so important for SP500 index in the next paragraph.

For any broad index like SP500 index, there are many major resistance levels that the index must overcome as it soars higher and higher. The index flirts at the level slightly below a resistance for a prolonged period, and finally gather momentum to break the resistance. After breaking through the barrier, the index, sooner or later, will retrace and test the breakout point from above. If the index holds above the former major resistance point, then the index will soar until it hit another major resistance point. For SP500 index, 500 was such a major resistance point. SP500 index broke the 500 resistance in 1995 and soared higher and higher, but has never retraced to test this resistance point from above. That is why we consider 500 as a crucial support. In the worst case scenario SP500 index may test this 500 level from above. At this moment we do not anticipate that SP500 index will sink below 500 in this bear market.

Some readers may be interested in Dow Jones Industrial Average instead of SP500 index. When SP500 index was around 800 in 2002, Dow Jones Industrial Average was slightly above 7000. The major resistance of SP500 index at 500 corresponds to the major resistance of Dow Jones Industrial Average at 4000.