Market turbulence is far from done!

Since these corrections led to over-sold technical readings and were followed by higher prices, the view is, therefore, that stocks will shortly recover and make new highs. However, that is far from certain for a variety of reasons.

I remember well how, following a period of poor performance, in 1981/82 the US stock market took off like a rocket in August 1982. Suddenly, the number of stocks hitting twelve months new highs exploded and the market became very quickly over-bought.

The S&P 500 was already enormously overbought in technical terms following its rise from 102 on August 12, 1982 to 126 on September 17, but the S&P then continued its ascent to 144 in December 1982, and to 171 in June 1983!

So, the same way the stock market remained over-bought for a very long time in 1982/83, it could remain over-sold for a long time in 2007.

But the crux of the matter is that, for stocks hitting 12 months new highs to explode on the upside in 1982, they had to have been basing for a long time while the indices were still declining. But now we have the same situation in reverse.

Chart breakdown

For 52 weeks new lows to increase suddenly so sharply a large number of stocks must have broken down from extended topping formations.

Another point: If one looks at the recent market action we see a sharp recovery following the March 2007 lows until the end of May.

Then we have a trading range and a break out on the up-side in mid July, probably partly fueled by a well-known technical analyst who after having been bearish during the entire 2002 – 2007 bull market suddenly (and in my opinion inexplicably) turned bullish.

But, and this is the point, the break-out on the up-side was a “false break-out” move, as it quickly reversed. When this occurs the counter move is usually very powerful.

Market contagion

Also, it would be wrong to think that the problems in the US credit market will be isolated and not impact asset markets outside the US.

Tighter lending standards and higher borrowing costs in the US (as a result of spreads widening) will spread to other markets around the world. And since foreign markets outperformed the US since 2003 by such a wide margin some hefty corrections/crashes should be expected there as well.

On a recent trip to the US it came to my attention that a very large number of family offices and pension funds, which before hardly ever owned emerging and other foreign market equities, suddenly had up to 50% of their money overseas.

Assets in emerging market funds have more than trebled since 2003. The enthusiasm for foreign markets is certainly reason for some concern!