A Line in the Sand for the Market?

01/15/2008 12:00 am EST

Focus: MARKETS

Mark Leibovit

Chief Market Strategist, VRTrader.com

Mark Leibovit, editor of VRTrader.com, says the markets are at a critical testing point, but the longtime bull now expects stocks to head lower.

[On Friday the Dow Jones Industrial Average] fell 246.79, or 1.92%, to 12,606.30. The Dow had been down more than 300 points in the last hour.

Last Thursday's [apparent] “double bottom” generated zero upside follow-through Friday, which was clearly disappointing. From a strictly contrarian's perspective (one piece of the puzzle), rallies that fail off big market lows encourage the bears and discourage the bulls. This action generally helps confirm that a bottom has formed or is forming.

Coincident with this tape action is generally more “bad news” and we did get some Friday: American Express and Tiffany reported profits that trailed analysts' estimates. In addition, Merrill Lynch might take a $15-billion hit from its exposure to soured subprime mortgage investments, according to The New York Times. The nation's largest brokerage is also said to be seeking another capital infusion to help shore up its balance sheet.

The arrival of quarterly earnings reports this coming week will likely bring more “bad news” about how banks and brokerages have fared after suffering losses in the collapse of the subprime mortgage market. Pessimism is growing ahead of reports from the nation's biggest financial institutions. Merrill Lynch, Citigroup, and JPMorgan Chase are slated to weigh in this week.

We are at a critical trigger point in the marketplace—the so-called “line in the sand.” A break under Wednesday's lows at this time will trigger additional selling. Of course, [Treasury Secretary Henry] Paulson and [Federal Reserve Chairman Ben] Bernanke could step to the plate at any moment, forcing shorts to cover, joined by enthusiastic buyers, and the markets could easily and dramatically reverse to the upside.

However, I believe the writing is on the wall that even so the market wants to ultimately work lower before staging a more stable and/or substantive rally phase. We could likely see another 5% to 10% to the downside either right away or following another sharp rally.

As a result, I have switched to a Timer Digest Sell signal—a signal I would be more than happy to quickly reverse at lower levels. If we do experience a sharp rally here this week (which, by the way, would make me more optimistic about intermediate-term market potential), I feel it will likely be temporary until we fulfill the downside.

What type of downside am I talking about? In the Dow, 12,250 and more likely 11,750 or 11,690 by the end of the first quarter of 2008. There is even greater downside potential to 10,680 in a washout situation. [We] have to take this one step at a time. I have to call 'em as I see 'em and if I'm wrong, I'll do my best to get back on the bandwagon.

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