Perfectly Poised for a Crash and a Melt-Up ~ The Risk Averse Alert

Wednesday, June 18, 2008

Perfectly Poised for a Crash and a Melt-Up

Welcome back, friend, to my stock market forecasting oasis. You're here again at a most fortunate time. Money seeds we have just planted ... in ground rich in rock solid analysis ... are about to bear fruit.

The U.S. stock market accu-forecast is calling for several hot days of severe selling, with a 70% chance of a thunderous crash, followed by a heavy shower of tears.

Right now, all continues looking a lot like October 1987. Wednesday of options expiration week then, saw the S&P 100 sink and close to a new post-peak low. And so, too, was true today.


How about that nice bump in volume. We like seeing this because a still-unfolding capitulation rightly should bring more (and more) shares to market.

OEX 5-min

Yes sir, look at today's RSI when trading opened with a thud. It's the lowest reading since the S&P 100 took a hard turn south on Friday, June 6, 2008. Thus, we see RSI confirming the index's decline to a new, post-6.6.08 low. What else could we ask for?

Well, there's the fact RSI has yet to sink as low as was registered on Tuesday, June 3, 2008. What is this suggesting? It's telling me the S&P 100 has yet to blow. There's more selling still to go.

Now, how about that nice RSI recovery to a point of balance between buy-side and sell-side strength, this while the S&P 100 more or less trended sideways. Do you remember the last time we saw this happen?

It was during the stock market's initial leg down following its May 19, 2008 peak.

Everything presented yesterday suggesting further selling is imminent remains intact. In fact, if there ever were three consecutive days during which I was anticipating a steep decline, I would not want things under the covers looking any different. The set up for a collapse is, indeed, perfect.

Now about the "why" of what looks to be coming, I should like to expand a bit on a recent thought. I spoke of it last Friday (6.13.08) in "How Jim Cramer Might Soon Regret His S&P Oscillator Forecast."

There I detailed the June OEX open interest situation ... which, even now, remains much the same. I mentioned that, if you have read "Reminiscences of a Stock Operator," you have some better sense of how strong hands in the stock market work to shake weak hands of their shares.

Surely, should the S&P 100 be driven lower going into Friday's expiration, a raft of Put options will be moved "in the money." Subsequently, come early next week, the need to meet financial obligations could drive the writers of these positions into creating a tidal wave of selling.

You probably have not been given to consider a possibility so simple. So, let me describe what present circumstance rationalizes this view suggesting strong hands now are about to behave no differently than they did in October 1987 ... because, indeed, a big, bad, earth shattering collapse could have less to do with the typical spin about trouble here, there and everywhere, and instead be a manufactured event simply meant to shake weak hands of their shares.

Truth is this scenario seems to back the story behind the performance dichotomy we're seeing in major indexes. There's a reason the NASDAQ Composite has been holding up better than other indexes. For one, since the peak in 2000 it has been the most battered. Thus, there could be a perception of more unrealized value waiting to be pumped to irrational extremes.

No doubt there's also some measure of over-confidence and/or fearlessness giving rise to declining volume since the March bottom. Given the stock market's performance over the past quarter century, though, is it really any wonder?

Likewise, it plainly appears the greater preponderance of players do not wish to miss the next big rally. So, the embedded psychology behind dreams of American financial pie baked with the faith of our fathers remains very much alive.

Furthermore, outside the demise of Wall Street Structured Finance, the mechanisms for creating copious loads of credit continue lifting the financial system's burdensome debt load like a well-oiled body builder. Add to this a $3.5 trillion stash of steroids sitting in low-yielding money market accounts and we have an explosive mixture...

Here we call it melt-up fuel.

However, the simple fact of the matter is shares are not being offered up for sale.

So, maybe an October 1987-style panic is what's needed to get the show back on the road. It worked then, so why not now?

Think about it.

The crash of ‘87 was in the grand scheme of things a shakedown — a transfer of shares from weak hands to strong. You only need consider what followed the crash. The market never looked back.

This time, however, I don’t suppose we’ll be so lucky. Fortunately, though, we have plenty of time to explore the approaching prospect of a Dow 3600 bear market...

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© The Risk Averse Alert — Advocating a patient, disciplined approach to stock market investing. Overriding objective is limiting financial risk. Minimizing investment capital loss is a priority.

Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

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