The anatomy of the downgrade: What now?

Default, no! Downgrade yes! Is there any end to all of this? I’m sure there will be. Remember the famous pool table scene in “Eyes Wide Shut” where Sidney Pollack tells Tom Cruise, “Life goes on, until it doesn’t. But you know that.” Life will go on here as well. The U.S. will go on and so will financial markets.

So let’s rewind to last week where markets spent the majority of time declining. At some point last week the Dow broke an 8 day losing streak to be marginally up. It was down 9 out of 10 days which is close to some kind of record dating back to the 70’s. But there was an incredible amount of technical damage to the charts. Just about everything broke a pitchfork line, the March low or some Gann square out line. As you know, our overall take on these markets was as long as the SSE held the Gann square out line of 2640, we wouldn’t get overly bearish. As of late Sunday night it was down 96 and well below what I even believe can be a comeback point. It looks like the 2610 level might be resistance and a polarity flip and we might not see 2640 anymore.

But we are looking at sharp technical damage below the March low everywhere you look. As of Friday, the VIX was trading near 38 which was above the March high, a technical point most traders did not think they’d see taken out this year. You can only imagine what it will look like on Monday. So we know we have all of this technical damage. Then we had the jobs number on Friday morning which was a little better than expected at +117K. The markets actually popped early Friday morning on that number. But they evaporated just as quickly. I was a little concerned watching on television as the Squawk Box crew and the usual cast of economists was visibly relieved. If you wanted to see a market bottom it would almost have been preferable to see bad news so we’d get the wash out. The bad news only took about 10 hours.

But before that happened it’s very instructive to see that the visible relief on the jobs number is classic slope of hope behavior. When market participants can’t get the bottom they are seeking on good news that means the market is falling down the slope of hope.

Let’s not forget we are right in the 610-day window to the March 2009 Haines bottom. One of 2 scenarios is working here. Either we are going to have that bottom by the middle of this week or we are about to see the most bearish of all scenarios. For that I have to bring you back to the Lehman/Tarp scenario. Remember how the markets topped in 2007? First the Dow and SPX topped on October 11, 2007 and technology topped 3 weeks later. What ended up happening is the Lehman crisis hit on the 233 trading day down from the Dow top which turned out to be an acceleration point then the Tarp vote turned out to be on the 233rd trading day off the NASDAQ top. It also turned out to be an acceleration point. It’s the first I’d ever seen such a condition in all of the years I’ve been doing this work.

But here we are, a Black Swan event described in this column for you 2 weeks ago. Markets have been almost straight down ever since. I was thinking about the potential for an inversion low in the 610 day window. That would be great except for one thing: there’s already way too much technical damage to send these charts back up again. But we could have that low I’m looking for. It looked like we could get in on Friday but they just kept going. Now I’m thinking back to the 2008 point with the acceleration on the time window and can’t rule it out here! The 610 day window could possible be the point of recognition with a breakaway gap. Obviously that would be the most aggressively bearish scenario, but I can’t rule it out.

The higher probability still would be an incredible wash out on this terrible news event. This is, after all a Mercury retrograde period where emotions run high and patterns routinely overshoot or undershoot the price targets.

Let’s look at the bigger picture for a minute. If you’ve read my Gann article in the February issue of this magazine, you know the NDX 2008 bottom came in on a 21 year cycle point that is tied to the Dow crash leg in 1987. That range was 1108 points and the bottom for the NDX was 1108 weeks. It’s important to realize right about now how very powerful that pivot is. I’m not saying it can’t be taken out, but it would likely take the mother of all financial storms to take it out. That being said, this is still a Black Swan event that materialized relatively close to the top. The difference here from the 07-08 period is that bear market developed for an entire year before the crisis hit.

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