2008 Could Be a Rocky Year

01/07/2008 12:00 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, editor of the Option Strategist, says the charts and the Presidential election cycle suggest a stronger market, but it could have ups and downs along the way.

A chart of the Standard & Poor's 500 index [over the past 22 years] with [a] 500-day simple moving average [shows that the only time the line] has been decisively penetrated on the down side was during the 2000-2002 bear market. Hence, by this measure the current bull market is intact.

Interestingly enough, the 500-day moving average was recently at 1392 and rising. We know from a short-term chart that near-term support is at 1410. (It closed Friday at just above that-Editor.) Also, the August lows were at 1370. These numbers are fairly close together and define significant support for [the S&P 500]. Should they all be violated, it is likely that a bear market would be under way.

This is not necessarily a new stance for us, for we have been saying for some time that a violation of the 1410 level would have bearish consequences, but this is just another way of proving it. From the other perspective, the S&P is trading in a wide and rather volatile range between 1410 and 1560. A breakout above that range would certainly be bullish.

We can also look at the equity-only put-call ratios from a longer-term perspective. Usually that means considering the 55-day moving average (as opposed to the more usual 21-day). At this time, the 55-day weighted ratio has not yet given a buy signal. However, it likely will (since the 21-day ratios have), and thus the broad market will likely rally further, just as it did after the April and September buy signals earlier this year. [Meanwhile,] breadth is not positive from a longer-term perspective.

2008 is, of course, an election year. Politicians-especially the party in power-do not like to see the stock market go down prior to the election. But a more refined look as this general concept is available from Stock Trader's Almanac, by the Hirsch Organization-a reference book that everyone should have on his shelf.

It turns out that the politicians aren't always as adept at creating a rosy election year as they might like to believe, especially when the credibility of the party in power has been damaged or weakened, as is the case currently.

Hirsch points out that the last seven months of the election year have shown gains in 13 of the last 14 election years. However, the first five months of the year have sometimes contained nasty declines (2000 being a prime example).

In fact, those early-election-year declines can sometimes be severe enough that they constitute the start of a bear market (as happened in 2000). However, most of the time, the presidential year is positive, although less so when the party in power loses the White House.

[To summarize,] we expect that the market will remain volatile within a wide trading range. Furthermore, the fact that 2008 is a Presidential election year likely means that a new bear market will not develop at this time. However, any violation of the support at 1410 and slightly below would change that. In the meantime, the volatility should provide ample opportunities for strategic traders.

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